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Smart Tax Strategies for Lottery Winners

Lottery fever has been sweeping the nation, with eye-popping jackpots surpassing $1 billion, such as the astonishing $1.33 billion Mega Millions prize won by Illinois residents via an anonymous partnership. While many winners opt for the lump-sum payout, taxpayers who find themselves newly wealthy should consider another route: the installment option.

In the rush of excitement, misconceptions about installment payments often arise. Some wrongly believe that installment payouts cease upon the winner’s death, which is not the case. Fears of state or lottery commission bankruptcy are also unfounded, given that installment obligations are backed by a secure “laddered” bond portfolio. Concerns about potential future tax hikes and inflation are valid, but should be part of the overall analysis.

Choosing the lump-sum option for a multi-million-dollar prize can lead to regret. Opting for the lump-sum means taking a substantial hit of 30% or even more on the payout, while also paying the full tax amount in the first year of victory.

Aside from the discounted amount, a lump-sum payout carries federal taxes of 37% on amounts exceeding $539,900 (single filers) or $647,850 (joint filers) in 2022. Plus, many states impose additional taxes on these winnings.

To put the tax disparity into perspective, choosing installments and receiving over $539,900 annually could save around $53,990 each year due to the federal graduated tax structure. Over 30 years, this translates to approximately $1.6 million in projected savings.

Apart from the financial benefits, the installment option allows for long-term tax and investment planning. This strategy can prevent winners from squandering their windfall and potentially facing bankruptcy just a few years after their victory. For those in high-tax states, residency changes might help reduce state taxes on future installments.

In the realm of estate tax planning, choosing installment payments can impact the estate’s value based on present value calculations. Overall, the installment option offers numerous advantages, including tax savings, investment planning, and protecting against family, friend, or creditor access to the winnings.

In the end, for prizes exceeding $5 million, the installment option generally proves more advantageous. Yet, those anticipating higher future tax rates, confident of earning more than 5% on their winnings, or prioritizing immediate liquidity might lean toward the lump-sum choice. Deciding between these options demands careful analysis and personalized considerations. With a life-altering stroke of luck, expert advice is crucial to ensure wise decisions are made.

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