How Inflation Affects Lottery Winners
By: Kurt D. Panouses, Esq.
Florida Lottery Lawyer & CPA
With support from:
David Griffis, CFA
Vero Beach Global Advisors
Winners of lottery jackpots are faced with critical choices when it comes to obtaining their monetary prize. The biggest decision is whether to take the annuity over a 20-to-30-year time period (in most states it is 30 years), or a lump sum amount which is calculated by the respective lottery office (each state has their own protocol for determining lump sum amounts).
For most winners, the general rule has always been to accept the jackpot proceeds in lump sum. Rather than relying on the state to make paymentsto the winner over a period of time, most winners like to control their own fate by having access to the lump sum amount which allows them to choose their investment strategy, control the lifetime use of their funds, live within a budget, and control gifts to family members and friends.
In comparison, annuity payments are often made in graduating payments; in other words, each year the amount is a little bit larger than the prior year. Annuity payments may be a good option for younger winners as it allows them to have a continuous flow of income over a thirty-year period. Moreover, given that younger winners may not have investment knowledge and/or the ability to maintain their spending, annuity payments may be advantageous.
Over the years, as the attorney, I have personally counseled several jackpot winners, and most of my clients have opted for the lump sum payment. In addition, the lump sum amount has historically been approximately 74-78% of the published jackpot winning amount (before taxes). For instance, if an individual was to receive $25 million, the lump sum would, historically, be a little more than $19 million. This has been the standard for several years while inflation in this country was at a low value. However, during the calendar year 2022, drastic increases in inflation, caused by a variety of economic factors, have impacted lump sum percentages.
Following the real estate bubble in 2008-2009, the Federal Reserve lowered interest rates to historically low levels to spur economic growth. Prior to January of this year, those rates stayed at or near those historically low levels. One of the benefits of the low interest rate environment was that lottery winners would benefit from much higher lump sum pay outs. However, over the first five months of 2022, the interest rates have increased substantially. This is, in large part, due to inflation. The discount rate used to calculate the present value of a lottery win is normally based on what is called, “treasury strips” purchased by the state Lottery office to back their lottery obligations. For instance, in my state of residence (Florida), jackpot winners have 60 days after winning to choose between the two payment options. Once an election is made, it is final. If a jackpot winner chooses the cash option, they will receive one lump sum payment of the amount required on the prize determination date to purchase securities to fund the jackpot prize, paid over 30 years, less applicable withholding taxes.
When a state’s lottery identifies a need to purchase securities to fund an obligation (i.e., pay a jackpot), they typically follow the statutory authority for state investments that eliminate risk, to ensure the integrity of the Lottery disbursement system and produce annual sums of money over the required term of the investments. Essentially, this process requires a conservative investment in “treasury strips”.
On January 1 of 2022, the “treasury strips” benchmark rate was about 1.75%. As of May, this rate has increased to over 3.1 % with expectations that it will continue to increase. Generally, increased rates reduce the present value of lottery lump sum payments. For example, today, a $25 million dollar winner would receive a present value of about 65%, or $16.2 million before taxes are withheld. As previously stated, at the beginning of 2022, the lump sum amount would have been approximately $19 million—however, in the past few months, the amount has decreased by 12 %, or $3 million dollars, to currently total a lump sum amount of around $ 16 million. These amounts represent the actual lump sum values available and do not take into consideration Federal and/or State taxes that may be due and withheld. The rates fluctuate daily, and, so far in 2022, have nearly doubled since January 1.
Ultimately, it is extremely important for jackpot winners to find experienced professionals to assist them in the claiming process, protect their anonymity, and advise them before and after the claim. With the assistance of an experienced attorney, winners can maintain their anonymity, and make an informed decision regarding the ultimate cash flow. This is very important in determining whether to accept an annuity payment or to take the lump sum.