Taxes and Withholding on Lottery Jackpots

When you purchase a lottery ticket, you are buying the chance to win a huge sum of money. If you are lucky enough to select the winning numbers, you will either receive the full jackpot or share it with other winners who have also chosen all of the right combinations. Many people spend a small amount of money on tickets every day or several times a week. While it may not seem like a lot, it adds up over time. If you are spending this much on a regular basis, you could save by switching to alternative spending options.

The odds of hitting the jackpot are mind-boggling. A professor at Duke University recently told WRAL News that there are 302,575,350-to-1 odds of getting all five white ball numbers plus the Powerball. That’s a lot better than the chances of being struck by lightning hundreds of times, but still no reason to go out and buy a lottery ticket.

What’s even more awe-inducing is that if you are one of the lucky winners, you will be responsible for paying a substantial tax bill. The initial prize check is for 2.5 percent of the total, or $250,000 (with some taxes withheld), two weeks after the winning numbers are announced. Each year, the percentage of the jackpot paid in annual installments goes up by a tenth of a percent, and you’ll ultimately receive 5 percent of the total prize after 29 years.

Lottery companies know that most people want to take the lump-sum option, which provides immediate access to the entire jackpot after taxes. That’s why they advertise the jackpot amount prominently, with a cash option depicted in smaller type beneath. What’s often forgotten, however, is that interest rates influence the size of the advertised jackpots. Typically, the higher the interest rate, the lower the lump-sum figure.

Whether you choose the annuity or lump-sum payment, lottery officials will have to withhold federal taxes and state income taxes from the prize money, which can add up quickly. For example, on a $50 million payout, federal taxes will be withheld at 24%. Besides the taxes, you’ll have to decide how to spend or invest the money. You’ll need to hire an attorney, accountant and financial planner to help with these decisions. You’ll also need to consider your privacy, as some states require you to reveal your name and hometown if you win the jackpot.

Many lotteries offer a lump-sum or annuity option for the prize. A lump-sum option means that you’ll get one payment for the whole jackpot, while an annuity will pay out a series of payments over the course of 29 years. Lottery experts say that the best option for most people is the annuity, because it is more tax efficient. You’ll also have more control over the amount of your jackpot by choosing an annuity.