The Powerball jackpot continues to climb and has now reached nearly $2 billion, making it the biggest lottery prize in the world. There were no winners for last Saturday’s draw, continuing what is now a three-month jackpot streak that continues to grow.
The next draw is tonight, offering yet another chance at a $1.9 billion windfall. With so much money at stake, here’s a rundown of the most common mistakes people make when they suddenly strike it rich.
1. Choose a lump sum payment rather than an annuity
Jackpot winners have two choices as to how they wish to receive their payout. The options include annual payouts every year for 30 years, which in this case would be $63 million, an amount that collectively totals the $1.9 billion jackpot.
Or alternatively, winners can choose to take a one-time payout, a sum well below the billions currently in play. Those who choose an immediate cash payout will receive $929 million.
Taking this one-time payment may be a bad decision, however, says Pacifica Heritage Robert Pagliarini, certified financial planner and investment manager specializing in working with lottery and Powerball winners.
“People almost always choose the lump sum payment instead of the annuity, which is hands down the biggest mistake,” says Pagliarini. “I get it, I get it why. People want the money now. The thing is, people can do whatever they want with the money. For some people, it’s totally okay to take a lump sum, unless you make mistakes.And what we know about lottery winners is that they don’t make the best financial decisions.
The benefit of taking the annuity is that even when winners make financial mistakes with their windfall, there’s still $63 million to come next year, Pagliarini says.
“You can give it away, spend it too freely, invest it badly and then you get a rebate because you get that payment every year for the next 29 years,” Pagliarini says.
There are also other advantages to taking the annuity payment, including the delay of the tax burden. When receiving the one-time lump sum payment, winners are required to pay taxes on all that money up front. That’s a 37% federal tax rate and depending on where you live there will also be state taxes to pay. Out of $1.9 billion in winnings, federal taxes alone would amount to just over $700 million.
However, when you opt for annuity payments, you only pay taxes on the annual distributions of $63 million, which significantly lowers your tax burden to approximately $23,310,000 per year. And your last tax payment isn’t due for 30 years.
Annuity payments can also allow winners to adjust more gradually to their wealth. “Taking the lump sum can put the winner in control, but can sometimes overwhelm them,” says Michael Liersch, head of advice and planning at Wells Fargo. “Taking the annuity can help spread the gains over a longer period, helping the earner adjust to the new wealth.”
2. Overestimating Your New Wealth
Clearly $1.9 billion – a cash value of $929.1 million– that’s a lot of money. But even when you’re talking such big numbers, winners end up thinking they have more money to spend than they actually do.
“Even though the lottery jackpot is $1.9 billion, the winners don’t actually have $1.9 billion,” says Pagliarini. “If you make the mistake and take the lump sum, that halves your earnings to about $800 million. After you pay your taxes, you probably have about $400 million. So immediately you’ve gone from approximately $1.9 billion to $400 million.
And none of this takes into account the possibility that you are not the only jackpot winner. When there are multiple winners, the jackpot is split evenly between them.
“If there are two winners, the prize is split 50-50 and so on,” says Pagliarini. All of this means that the amount of money you end up with is likely to be less than you actually think.
The key point here is that it is important not to spend until you understand the exact amount of winnings you will actually receive and the tax charges associated with that money. It’s a good idea to contact a tax professional right away to help sort out these questions and help you plan appropriately.
3. Treat winnings like Monopoly money
When you win millions of dollars, the money may not even seem real, which makes you feel more comfortable spending it freely, without thinking too much about it. Some financial advisers describe this as viewing money as Monopoly money, a reference to the popular board game.
Additionally, there are a variety of emotions related to money and how we handle spending choices. Letting emotions influence spending and decision-making as a lottery winner can be a downward spiral, which can even lead to bankruptcy.
“The mindset of Monopoly money knows no boundaries. It’s hard for many to control their material desires. Having a red Ferrari is fine, but having a blue one would be just as good. says Philip Richter, co-president, president and partner of Hollow Brook Wealth Management, a company that provides wealth management services, including investment management and tax and estate planning. “The consuming nature of modern American society can cause many of us to want more and more even though our lives are already abundant. If one didn’t grow up in a privileged world, it’s tempting not only to keep up with the Joneses, but go far beyond them.
Pagliarini agrees, pointing out that because it’s such a huge amount of money, it just doesn’t seem tangible to people.
“Because you didn’t win it and you know you didn’t win it, you’re going to treat it differently. It will not have the same seriousness as if you had deserved it. You’re going to spend it more freely, give it away more freely, and make riskier investments,” says Pagliarini.
The best way for lottery winners to avoid this monopoly money trap is to have a trusted investment professional as your partner who, as fiduciary, will look out for your best interests at all times. “This trusted advisor will say no to frivolous spending and write a disciplined, quantitative, and ongoing financial plan that considers income, expenses, risk, and asset allocation,” adds Richter.
A professionally developed financial plan will outline what can reasonably be spent on a monthly, quarterly and annual basis. Which brings us to the next error:
4. Not consulting finance professionals
Managing the level of money associated with a Powerball jackpot is a once-in-a-lifetime event for the average individual. But for some people, such as wealth managers, CPAs, financial advisors, etc., managing huge sums of money is what they do on a daily basis.
If you happen to be one of the lucky winners, be sure to immediately surround yourself with a team of experienced experts who can help you successfully manage your financial future, including advising you on the wisest investments to do and how budget the money.
“This team should include a lawyer, a tax specialist and a financier,” says Pagliarini. “You want to work with people who have been through this dozens or even hundreds of times. And you want to rely on them.
5. Being the victim of a lifestyle change
With millions, sometimes even billions, of dollars at your fingertips, it’s natural to be tempted to splurge on big purchases like a car or a house that you couldn’t afford before. These types of purchases are examples of lifestyle drift, which is when increased income leads to excessive discretionary spending. But all those new possessions can also be expensive to maintain and increase your cost of living.
“Having unrestricted access to hundreds of millions of dollars provides unlimited opportunity…planes, helicopters, racehorses and many homes are no longer just at hand, they are a tangible reality,” says Richter . “These types of luxury assets require enormous upkeep and generate significant ongoing expenses.”
In other words, building empires consisting of multiple homes, cars, and other major purchases can result in expenses that ultimately exceed your financial capabilities, even as a lottery winner.
“People really try too hard to turn their lives around. They feel like they have to turn everything upside down just because they have all this money,” Pagliarini says. “But you don’t have to do that.”
Instead, figure out what has worked well for you in the past, what you like, and what you get pleasure from. And focus on those things. “Try to use the money to improve your life rather than drastically disrupt it,” says Pagliarini.