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Dear Dr. Don,
I won a state lottery. There is no lump-sum payment option available, so I am scheduled to receive 20 annual payments of $50,000, or $35,000 after taxes.
Several companies have offered to give me a lump sum equal to half the total payment stream, or $500,000, before taxes. Over 20 years I would receive $700,000 after taxes with the annual payments. I have debts of about $100,000, but I have additional income of about $100,000 besides the lottery payments.
I figure that after taxes with a lump sum, I would end up with somewhere between $250,000 and $300,000. Should I keep the annuity or sell it? Either I or my estate is guaranteed the $35,000 annual payments from the lottery.
– Rhonda Remunerate
Dear Rhonda,
The decision to assign the payment stream to a firm in order to receive a lump sum today will, as you point out, also accelerate the income tax obligation to today. You’ll pay ordinary income taxes on the lump-sum payment.
The maximum federal income tax rate of 35 percent plus any applicable state or local income taxes would reduce the $500,000 lump sum to around $300,000 after-tax. (I’m assuming an additional 5 percent in state income taxes.)
Comparing a $300,000 after-tax lump sum to a $35,000-per-year after-tax payment stream over the next 20 years — assuming the first $35,000 payment is received today — gives an implied interest rate of 11.55 percent. Bankrate’s “Savings withdrawal calculator” confirms these numbers.
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