Why You Might Hit the Jackpot in 2014
Jan 31, 2014 | Ginny Grimsley
If current trends continue, 2014 will be the year of mega lottery jackpots and generous (if not millionaire-making) inheritances, says Ted Bernstein, a longtime life insurance consumer advocate.
Five of the top six biggest lottery jackpots in the United States occurred in 2013 – from No. 2, the $648 million Mega Millions jackpot before Christmas, to No. 6, a $399.4 million Powerball pot.
Talk about striking it rich!
However, odds are slightly better that you’ll claim a nice inheritance, whether it’s an estate or life insurance benefits, Bernstein says.
“American retirees plan to leave their beneficiaries some of the biggest estates in the world,” he says, citing HSBC’s recent survey the Future of Retirement Report. “A fifth of those polled will leave legacies of more than $390,000.”
Most who strike it rich in the lottery — 98%, according to some experts — opt for a lump-sum cash payout versus guaranteed checks over 30 years, Bernstein says.
“Those who receive life insurance benefits almost always opt for the big cash up front, too,” he says. “But in both cases, you’re almost always better off financially if you choose the payout over the lump sum.”
An estimated 70% of people who experience a sudden financial windfall are broke within a few years
That’s according to the non-profit National Endowment for Financial Education, Bernstein says.
“First, you have the unexpected emotions that go along with suddenly having more money than you ever expected,” he says. “People react in unpredictable ways — and that leads to a lot of bad decision-making. Second, people want control of the money, even if they have zero experience managing large finances. That’s a recipe for disaster!”
Having a guaranteed check from a life insurance company provides valuable safeguards, he says.
Generally, you’ll get more money if it’s paid to you over time
“If lottery and life insurance benefits are paid over time or by installment, they will pay more as the money is allowed time to grow,” Bernstein says.
For a $400 million win, you’d get only $223.6 million if you took the lump sum option. You’ll get the full $400 million only if you choose deferred payments, he says.
If you own a life insurance policy, you can now opt to purchase a policy that instructs the insurance company to pay the proceeds over time, and your beneficiaries may get more because of guaranteed interest, he says.
“Since the insurance company knows it will have more time to pay, you can either choose to pay a lower premium or get up to 50% more in face value for the same premium,” Bernstein explains.
The tax hit — lump sum versus checks over time
In most cases, for a huge lottery jackpot, you can expect to pay the highest federal income tax rate, which is 39.6% in 2014 after the first $450,000 or so for a married couple filing jointly.
“On the $400 million jackpot, you’ll have a net $135.1 million after federal income taxes,” Bernstein says. “If you take the win in checks over 30 years, you’ll have $242.9 million after federal taxes.”
With life insurance benefits, there are some caveats, but generally you won’t pay taxes on the lump sum.
“If you take the benefit over time, you won’t pay tax on the life insurance portion, but you will on the excess interest,” Bernstein says. “You still come out ahead because you’ll have more money over time!”
Almost any way you slice it, if you have a choice of taking your windfall in a lump sum versus deferred payment, you’re safer and potentially better off opting for the latter, Bernstein says.
“If the payments are spread over time, you don’t have to worry that it won’t be there 20 years from now,” he says. “It’s not like the stock market — the payments are guaranteed.”