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The current Mega Millions jackpot is standing on $868 Million USD, while the Cash Option for the same Jackpot is $494 Million USD.

The winner of any of Mega Million's jackpot has two options to claim their winnings:

Annuity option:

The Mega Millions annuity is paid out as one immediate payment followed by 29 annual payments. Each payment is 5% bigger than the previous one.

For a typical jackpot of $100 million, the initial payment would be about $1.5 million, and future annual payments would grow to about $6.2 million.

When the jackpot is $200 million, each payment is twice as big. When the jackpot is $50 million, each payment is half as big, etc.

Cash option:

A one-time, lump-sum payment that is equal to all the cash in the Mega Millions jackpot prize pool.

The Question

First, what is the true meaning of the "Cash Option" where it is equal to all the cash in the jackpot? Is that the $2-$3 USD that cost to buy each game ticket? If so, where does the extra ($868 - $494 = ) $374 millions come from in the Annuity Option?

Second, if the jackpot winner decides to take the Annuity Option, they will simply pay the highest income tax for their status. For example, single person, paid annually would pay $150,689.50 plus 37% of anything in excess over $503,700. So if we generalize for this jackpot, divide the $868 by 29 equal payments, it would be about $29.93 Million a year, and the federal income tax would be $11,038,803?

Would the $494 Million Cash Option be taxed the same way, for a total of $182,744,320 federal income tax?

Lastly, what are the best methods to avoid paying so much tax on lottery winnings/earnings?

  • "tax would be $11,038,803?" Per year for 30 years, for a total of ~$330M. – Kevin Oct 17 '18 at 16:13
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    "I love paying taxes. If I'm paying a lot in taxes, I must be making a lot of money." – Beanluc Oct 17 '18 at 19:06
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    You can avoid paying taxes on the winnings if you donate the winning ticket to charity. – Andy Oct 17 '18 at 20:40
  • As of 10/18/18: "How Much You'll Actually Take Home from the $970M Mega Millions Jackpot" ... twocents.lifehacker.com/… – Bob Baerker Oct 19 '18 at 12:17
  • The cash option is not about taxes. You can choose cash or an annuity - simple. Lotteries in the US are a scam. Play Euromillions - if you win you get every cetime. – Fattie Nov 13 '18 at 17:03
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Why is there a difference between the jackpot and the Cash Option - $374 million dollar difference.

Taxes aside, suppose you were given a choice of $900 million today or $900 million over 30 years. Obviously you'd take the $900 million today and invest it wisely, earning 10% a year and having much more in the future. You wouldn't just buy mansions and yachts, that would be foolish...

Now suppose I give you a choice of $500 million today or $900 million over 30 years. Now the right answer is not so obvious. What you should look at is the internal rate of return of the annuity versus the lump sum. Meaning - at what rate of return would getting the money today versus getting the annuity be equivalent? Then you need to decide if you can get a better rate of return if you took the money today and invested it. If you CAN, then you'd be better off taking the lump sum and investing it. If you CAN'T, then you'd be better off taking their annuity.

As for the taxes, well first win the lottery, THEN worry about the taxes. But yes, it would be considered income either way, and you'd pay the highest tax bracket on virtually all of the winnings.

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    Gambling isn't an investment, its entertainment, which has a human value. You can show, for example, that playing blackjack and making reasonable bets in Vegas has an expected cost less than that of watching a movie over the same period. – user71659 Oct 17 '18 at 18:17
  • @user71659 I'm not sure what your point is. My intent was to illustrate why there are different payouts, which is based on the time value of money. – D Stanley Oct 17 '18 at 18:19
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    It's a direct response to your statement that "The lottery is designed for those that have no other realistic way to get rich." – user71659 Oct 17 '18 at 18:20
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    @user71659 Fair enough, but I'd argue that the value in the lottery is more around the possibility (slim as it is) of getting rich than entertainment value (no one expects to win millions at the blackjack table, but it can be fun to try and beat the dealer), – D Stanley Oct 17 '18 at 18:22
  • Okay folks, I've taken that paragraph out since it's tangential to the question. – D Stanley Oct 17 '18 at 18:27
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To answer the question of why the differing amounts of the annuity versus cash option, the way a lottery works is that out of the ticket sales, a certain amount is set aside for the prize pool. When no one wins, the grand prize pool is carried over and added to the next prize pool. It doesn't take long to notice that more people buy tickets the larger the jackpot is.

At some point, lotteries realized if that they purchased an annuity with the prize pool, then they can claim an even greater jackpot figure of the total annuity payments, instead of the present day cash value and even more people will buy tickets. Of course, most people want their money upfront, and for lotteries that are willing to do so, they list the cash option value which is more or less the "real" jackpot that they would purchase the annuity with.

  • Exactly. It's a straightforward scam. If a normal company did this (not the government), they'd be shut down and arrested. – Fattie Nov 13 '18 at 17:04
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    @Fattie I wouldn't call it a scam, per se. By this logic, a mortgage is also a 'scam'. Both are just the time value of money. 1st week economics class stuff. Granted, a lot of people don't understand it, but that is also true for a wide, wide variety of many other things in the economy today. – R. Hamilton Nov 14 '18 at 18:38
  • @R.Hamilton - sure, but I think it's an advertising standards matter. They're deceptively advertising an incorrect figure. A normal company would be criticized or caused to stop it ! – Fattie Nov 15 '18 at 3:24
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I was wondering why is there a difference between the jackpot and the Cash Option - $374 million dollar difference.

If you win Mega Millions, you win the amount they advertise (the prize pool). They invest the amount necessary to provide a return of the advertised amount in zero coupon bonds / strips. You receive all monies earned from those investments, aka the annuity option.

If you take CVO (cash value option), they will pay you the investment cost of the zeros not the amount in the prize pool.

As a side note, when rates are lower, a zero is worth more and therefore, the lump sum is worth more.

If you take the cash option, the lottery withholds 25 percent for federal tax and depending on where you live, another 6 to 9 percent for state taxes.

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    Don't confuse how much is withheld with how much tax is actually due. – Beanluc Oct 17 '18 at 19:08
  • How can one confuse how much is withheld with how much tax is actually due when they are two different things? – Bob Baerker Oct 17 '18 at 19:21
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    The OP is asking how to PAY less tax, not how to have less withholding. Your answer doesn't seem to address that in any way other than a very misleading one. – Beanluc Oct 17 '18 at 19:24
  • The OP has asked multiple questions in his original question as well as in his comments. I addressed his curiosity about where the "$374 millions comes from in the Annuity Option." I mentioned what the general range of withholding is if the CVO is taken, of which you are confusing with the tax liability. Feel free to write your own Answer that addresses his other questions, including how you believe that he can "PAY less tax". – Bob Baerker Oct 17 '18 at 19:31
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    This level of money is above my pay grade. All I can say is that when they give you the money, it's taxable income and I have no idea how it would be possible to intercede in that process. Once you have the money, the tax bill is due. After that, you can invest in investment vehicles that limit taxation. A trust is used for minimizing estate taxes but again, that's once you have the money in your possession. – Bob Baerker Oct 17 '18 at 21:31
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First, if you've won the lottery, congrats. You should hire a tax advisor. The below is not tax advice.

Let's use hypothetical, simple tax brackets: 0% for the first 10k, 10% for the next 100k, 100% thereafter. Let's assume you quit working after you win a $1bn lottery.

If you choose the lumpsum, you get to keep 10k for the first bracket, 10k for the second bracket, and then you lose the rest. $20k total.

If you choose a $1mn / year for life annuity, the amount you get home after tax in the first year is the same as if you chose the lump sum. But now, you get that same amount for the rest of your life.

This is the effect of progressive taxation. The bigger the jumps between tax brackets, the more you benefit from the annuity relative to the lump sum.

Now, let's say there are no taxes and you have the choice between $10mn today or $1mn for 10 years. If interest rates are positive, you would choose the lump sum. You could put 1mn in your checking account for this year and invest the remaining 9mn in a (zero coupon, but don't worry about this detail) treasury bond ladder. In all future years, you would receive more than $1mn in bond maturities. Positive interest rates make the lump sum more attractive.

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    That is not what I asked really. I was wondering (1) Why is there a difference between the jackpot and the Cash Option - $374 million dollar difference. (2) Also was wondering about what are the tax rules for lottery winnings, and (3) how to avoid paying too much taxes. You didnt really answer any of these. – KingsInnerSoul Oct 17 '18 at 15:47
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    @KingsInnerSoul If you have multiple questions, it might be best to break them into separate posts. – Tashus Oct 17 '18 at 15:55
  • Knowledge of any of the answers is required to answer all of the answers. They are like steps 1-2-3. Not really separate answers - more like a simplification of a complex question. – KingsInnerSoul Oct 17 '18 at 16:05
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    @KingsInnerSoul At least (1) is a different question. I'd also suggest that, if I were to win, I'd have so much money after taxes that I wouldn't worry about them. – David Thornley Oct 17 '18 at 17:17
  • If the amount of the payout puts you in the maximum tax bracket, there's no way to avoid the tax man, other than maybe moving to a state with a lower tax rate. For me, winning would probably kill me: "You hear that, Elizabeth? I'm coming to join you, honey!" ~ Redd Foxx – Bob Baerker Oct 17 '18 at 20:48

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