How to Minimize Your Lottery Tax Bill

When the Powerball or Mega Millions jackpot hits a staggering sum, lottery fever sweeps the nation. But the huge prize isn’t all you’ll get when you win: federal, state and local taxes will take a bite out of your winnings. Fortunately, there are strategies to help you minimize your tax bill.

The Big Picture

When you see a jackpot reach the billions, it can be hard to wrap your head around the number. But those eye-popping numbers are the result of lottery formulas and math, not pure luck. The bigger the jackpot, the harder it is to hit. And that’s by design. In recent years, lottery officials made it harder to win jackpots, encouraging players to buy more tickets by raising the odds of winning. As a result, jackpots are growing faster and larger than ever before.

Lottery jackpots are advertised as a lump-sum amount, but that’s not really what happens. The prize is actually an estimated payout of the total sum that would be paid if a winner accepted the annuity option. The jackpot estimate is calculated based on the amount of money that has accumulated in the prize pool, including funds that have rolled over from previous drawings, expected sales for the next drawing and market interest rates for the securities that will be used to fund the annuity payments.

As a result, the higher the interest rate, the greater the annuity payment. This explains why the current record-setting Powerball jackpot has been so big even though there hasn’t been a single winner since New Year’s Day.

Those with low incomes make up a disproportionate share of lottery players. Critics say that the games are little more than a disguised tax on those who can least afford it. State governments collect a percentage of the ticket sales and shift some into their general funds. Other states use the profits to support specific initiatives, such as education or state parks.

If you won the lottery, how would you choose to spend your windfall? The first thing you’ll want to do is secure the winnings. Then it’s time to consult legal and financial professionals with experience in handling large windfalls. Depending on your goals, you might be better off taking a lump sum payout or accepting annual payments over decades.

A Lump Sum Payout

The biggest advantage of a lump-sum payout is that you’ll have full access to the entire jackpot, after taxes, right away. The biggest disadvantage is that you’ll likely face a high tax bill, possibly in the top federal bracket of 37%. If you’re unsure which option is best for you, talk with an accountant or wealth adviser who has experience helping winners manage their windfalls.