We have been seeing record-setting numbers with the Mega Millions prize climbing towards $1.55 billion, getting closer and closer to setting an all-time record high. The last time we saw numbers this high was from a winner in October of 2018 taking home $1.537 billion.
Anytime someone comes into newfound wealth, it’s an exciting yet unnerving feeling as people are overwhelmed with decisions they thought they would never have to make and the age old questions around maintaining your wealth before you spend it all. After all, 68% of the US economy is driven by consumer spending, however, studies are mixed showing some lottery winners of more than $200,000 in earnings have had their lives positively affected, while a more disputed study shows inherited wealth of people in their 20s, 30s, and 40s spend roughly half of their inherited wealth within a few years. Regardless, let’s take a look at how to keep yourself and your wealth happy.
In initial discussions with our clients, we delve into determining their hurdle rate - the threshold at which they can achieve their objectives, or the minimum rate of return essential for progress, all while minimizing undue risks. If they desire more of a return on their investments, we discuss the difference between needs and wants. Anything above their desired rate of return tends to turn into excess. That story never ends well, which is why it is extremely important to flush out your personal life goals with a financial professional, attorney and accountant. What amount of money will let you go on idyllic vacations you can now afford, give to family or charity, upgrade to your Barbie dream house or finally get that Equinox membership?
An accountant is an important piece of the puzzle because after subtracting the cost of your ticket you owe federal and state (depending on where you live) income tax on the rest. I know, the IRS was not on your list of friends or charities, but their piece of your pie is an important number to consider. Right away, the IRS withholds 25% but depending on how much you win, you may still owe more the following April when you file. Just to give some context, that is $375 million you’re giving back to Uncle Sam as soon as you win. Considering top federal income tax brackets are 37% which is an additional $180 million, it’s a check you want to know you are writing sooner rather than later as you go forth in figuring out what your new financial future holds. Depending on where you live, your state may have their hands out on earnings too. For all our New Yorkers out there paying an additional 13% in state income tax, if you think just because you went to NJ for the winning ticket and the earnings were paid out there, think again. You will owe your state of residence at tax time but will receive a credit for the amount you already withheld in the ticket winning state.
After winning the lottery, one is faced with the choice of lump sum earnings or a series of monthly payments (also known as annuitizing payments). Which one is better? The answer is a personal question but also a question about time value for money. If you take the annuitized payments, you spread the tax liability over a certain number of years but if you are going to invest a portion of your winnings, investing a dollar today may be worth more than investing a dollar 5 years from now. Taking a lump sum payment now also allows you more control over your assets in creating a plan that meets your immediate (3-6 months), intermediate (3-7 years), and long term (10+ years) objectives. It’s also important to consider how your assets are growing. We refer to this as asset location. Make a plan that allows for a portion of your assets to grow tax free (like a Roth IRA), tax deferred (Traditional IRA or low-cost variable annuity), and standard brokerage assets that are taxed on capital gains and interest income or dividends. Make your money work as hard as you do while being as efficient as possible.
Winning the lottery or inheriting large amounts of money can be absolutely life changing and put you on a completely different life trajectory than you ever thought possible. No matter how large your winnings are they are not infinite, so put yourself on a path to achieve exactly what you want in your life. Take control by surrounding yourself with the right group of people who are going to get you there.