So you won! Your first thought is most likely, “Should I take the lump sum or the annuity payments!?” While this is important (and we’ll get into more details about that question below), there are other critical things to address.
Big Budget, Big Mistakes
We’ve seen lottery winners file bankruptcy, and we’ve also had clients that won the lottery and then fell into trouble with the IRS. It can happen easily to anyone; especially someone that’s not used to having a lot of money. When you’re dealing with a lot of money, a ‘simple’ mistake can cost you everything.
You always wanted to be voted “Most Popular”!
And now you will be.
If you win the lottery, you’ll notice — rather quickly – that a lot of people are suddenly very interested in you. You may have even tried to remain anonymous, but that can be a challenge. First, you’ll get excited and want to share the good news! Second, even if you do keep quiet, some states make it hard for you to keep your anonymity. Only 5 states currently permit winners to claim a ticket anonymously without question (KS, DE, MD, ND, OH), and certain State Lottery Commissions will not release the winnings until a press conference is completed.
Now that everyone knows you won the lottery, they’ll be coming at you from all sides. Friends, family members, and strangers alike. It can be difficult to wade through this sea of people and figure out who is trying to manipulate you. Unfortunately that is not true, and not everyone will have your best interest at heart.
Take action – Your supply of money is not inexhaustible
First, think about how much money you’ll actually have. Here’s some perspective:
If you won a million dollars, you will have about an extra $20,000 a year IF you want to be investing your money so it continues to grow (hint – you want to do that). If you’ve invested in something where you don’t have to pay taxes (yup – you want to do that too) you’ll likely get about a 6% return on your money. If you are paying taxes you’ll get about 4% or $40,000 a year. You can’t take it all, you’ll need to keep investing it… so you’ll get about half that. Half for now, and half to reinvest.
If you won 10 million dollars, you’ll get about an extra $200,000 a year. Now, I’d certainly take an extra $200,000 a year, but you have to think about what that will actually buy. An upper-middle class home, or maybe a BMW and a vacation. And what if you want to leave some behind for your heirs?
Make a budget
You may not think you need to. Come on! You’re rich now! But creating a budget is of the utmost importance. It is easy to get pulled into a ‘rich’ lifestyle and spend, spend, spend. You’ll want a nice house, nice cars, nice vacations, and pretty soon maybe some botox, a personal trainer…basically an unsustainable lifestyle. Don’t be reckless; get every dollar to work for you.
Create a trust
A trust is a relationship where property is held by one party for benefit of another. This will help you to keep your money safe from others, and potentially yourself. The trustee is the person responsible for managing the assets and making payments, and has incentive to manage your money correctly. There are two different kinds of trusts, revocable trusts and irrevocable trusts, and you should know which would better benefit your situation.
A revocable trust is a trust whereby provisions can be altered or canceled dependent on the grantor. During the life of the trust, income earned is distributed to the grantor, and only after death does property transfer to the beneficiaries.
An irrevocable trust is a trust that can't be modified or terminated without the permission of the beneficiary. The grantor, having transferred assets into the trust, effectively removes all of his or her rights of ownership to the assets and the trust.
In this case a revocable trust wouldn’t help you as much because if you are sued, someone can take your money. Yes, with an irrevocable trust you’ll be giving up some control. But if you want asset protection or substantial reduction of taxes, you have to give up a little control of your money. Obviously the trustee should be someone you trust, and you should work closely with them to plan your budget.
Lump sum or annuity payments?
Ah, the million dollar question. Generally people think that the annuity payments are a better option because then you’ll be taxed less, and will have an endless stream of money coming in. We disagree.
If you choose an annuity payment, every year you will have to deal with complicated financial issues. You can make errors managing the money, or pay accountants and lawyers to assist you. You also don’t know what future tax rates will be (most likely, higher). Lastly, if you choose an annuity but then change your mind and “need the money now”, you’ll get hit with an additional 12% interest rate on the lump sum.
With the lump sum, the taxes are withheld off the bat and you know exactly how much money you have to work with. It’s easier to come up with a planning strategy and take immediate control and begin investing is some tax free plans.
Taxes
You will be hit with a 25% federal withholding tax and local state income tax right away. Once that has happened, you’ll want to figure out how to reduce your tax liability.
There are ways to keep your taxes at a minimum, and a professional can help you decide what the best choice is for you. Personally, we are big fans of PPLI (Private Placement Life Insurance) for tax free investing. Learn more about it here.
Bottom line – if you win the lottery, take control and have a plan. And if you need assistance, contact us. We’re here to help. Call us at 888-727-8796 or email info@irsmedic.com.
