Written by: Corey Janoff
Last week, with the Powerball winner claiming the grand prize of $730 million and the Mega Millions at $1 billion, it got me thinking – what would I do if I won the lottery that much? Doesn’t everyone wonder that every once in a while? What would I do first with the money? I know my wife wants a new backsplash in the kitchen, so I supposed we could get that done. Or buy the forever home. Should I claim the lump sum or the 30-year payout? Do I tell my friends and family? Do I tell my wife? (Just kidding….sort of). How do I ensure I don’t go bankrupt like a lot of lottery winners? It all starts with putting together a plan. Here are some initial thoughts on how I would react and what I would do.
Holy Schnikes, I Just Won the Lottery!
Double-check the numbers. Triple check. Is this the right date I’m looking at? OMG, I think I won the lottery. I better not lose this ticket. Do I sign it and run it down to the lottery office to claim it? If I do that, then the media will know it is me that won, and I will get bombarded by solicitors. I don’t want that. Maybe I should give it some time before claiming the prize since you have a year to claim it (or so I have heard). But then I might lose the ticket. Decisions, decisions.
Getting Ready to Claim Lottery Winnings
If I don’t want the public to find out I am the winner, I need to set up a separate entity to claim the prize. I immediately call my estate planning attorney to ask what he suggests. I imagine he will recommend establishing some sort of trust that I can use to claim the ticket. His next available appointment is not for three weeks. I tell him I’ll pay him to double his normal rate if he gets me in right away. I just won the lottery – I can afford it.
We get the trust established, and I have all the necessary paperwork I need. I call up the lottery office and ask what I need to bring if I want a trust to claim the prize. I gather all the necessary materials and head to the office to collect my winnings.
Claiming the Lottery Prize
The big decision is whether to take the lump-sum payout or the 30-year payout. If I take the 30-year payout, I will get the full $1 billion of last week’s Mega Millions pot paid to me (before taxes) over 30 years. If I take the lump sum, I will only receive about 60% of the prize before taxes.
Now the investment professional in me would say I can probably invest that 60%, and it will grow to be quite a bit larger over the next 30 years. If I can average a 7% annualized rate of return, the roughly $600 million (before taxes) will turn into about $4.8 billion by year 30. That’s some serious paper right there. I could buy a pro sports team.
If I elect the 30-year payout and invest $33.33 million each year and average a 7% annualized return, I will have $3.37 billion by year 30. Math favors the lump sum. Divide those figures by two for the approximate after-tax results.
However, if I want to ensure I don’t blow all of the money right away, I will elect to take the 30-year payout. That way, the money will last at least 30 years. It will help keep my spending in check.
I’ve decided I’ll take the $33.33 million a year before taxes. About half of that will go to taxes (37% top federal bracket, 10% state tax in Oregon, plus 1.45% to Medicare, plus some other random little taxes here and there I am probably overlooking). So I’ll only receive $16.67 million per year for the next 30 years. Thanks to inflation, 30 years from now, the $16.67 million will only feel like $8 million in today's dollars.
Poor me. This is becoming less and less exciting already.
But wait! If I donate money to charity, I don’t have to pay taxes on it! I could feed a lot of hungry families and still be rich beyond belief while keeping some money away from the taxman.
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What to Do With the Mega Millions Money
I’m a financial advisor, so it would be pretty ironic if I went bankrupt after winning the lottery, as so many other lottery winners do. There are some options with how to invest this money to ensure it lasts forever. Some of them will be pretty boring, but ensure lifelong riches for myself and my family (and possibly some charities as well).
Option 1 – Annuities
Annuities often get a bad rap in the eye of public opinion. They can be restrictive and currently deliver low-interest rates. However, they are one of the oldest financial instruments in the world, and they serve a simple purpose: provide guaranteed income for a certain period of time (often for life).
Heck, the 30-year lottery payout I am taking is simply an annuity with a 30-year income stream.
For the next 30 years, I will be receiving $33.33 million. Let’s start by giving half to charity each year. Let’s pocket another $2 million for living expenses (you know I’ll be getting extra guac with my chips at Chipotle), investments, supporting family members, etc.
The remaining roughly $14 million I could invest in a single premium fixed annuity. It wouldn’t need to be an immediate annuity. I have a guaranteed income stream for the next 30 years, so I can defer collecting income on it and let the interest rack up.
I haven’t looked lately, but I would guess fixed annuities are probably crediting around 2-3% interest right now. That is $350,000 in interest per year. Even if we assume simple interest, the annuity will generate $10,500,000 of interest after 30 years, leaving me with $24.5 million in that annuity in 30 years that I can draw from.
In my early-mid 60’s, if I annuitize a $24.5 million annuity and elect a lifetime payout with 100% survivor payments continuing if my wife outlives me, I could probably collect about 3% of the starting balance per year for the rest of my life. That will be $735,000 guaranteed for life.
If I do the same thing in year two with my next round of $33.33 ($14 million after charity, spending, and taxes) and invest it into an annuity paying 2.5% interest, after 29 years of accruing, I will have slightly less, but still, around $24 million when the lottery payments stop. I could collect get around $720,000 paid out annually for life from that deposit.
After only two years of depositing a little over half of my lottery winnings into annuities, I have created almost $1.5 million of guaranteed annual income for myself for the rest of my life after the 30-year lottery payout stops.
Repeat this with 28 more years of depositing a chunk of my lottery winnings into an annuity. I can create a pretty substantial income stream that is guaranteed for life (assuming the annuity companies stay in business). I would deposit a total of $420,000,000 into 30 separate fixed annuities. The total interest accrued at a 2.5% interest rate would be $157,500,000. That coupled with the $420 million deposited totals, $577,500,000. Annuitize it and collect 3% of that balance annually for the rest of my life would give me over $17 million per year guaranteed for life!
This, of course, assumes interest rates never change and the same annuity products are available for the next 30 years. Unlikely, but who knows, there could be better options in the future.
The whole objective here is to protect me from myself. If I put the money in annuities, I cannot touch it until I am at least 60 years old. I can then flip a switch to assure the income streams continue as long as I am alive.
Yawn. This is the most boring lottery winner ever.
Option 2 – Treasury Bills
This route is even more conservative than the annuity strategy because it is backed by the full faith and credit of the United States Government. I could take my lottery payouts and purchase treasury bills! I’m lending money to the US Government in exchange for a small amount of interest. Who isn’t excited about that?
Let’s say I go with the same strategy as outlined above – half to charity, $2 million to live on, and $14 million to invest for the future in US government bonds. If I buy 10-year T-bills, I would currently receive 1.08% interest per year. That amount fluctuates daily, so it might be different by the time you read this. That is a little over $150,000 in interest per year. If I continually reinvest the interest, I can compound my returns.
In year two, I invest my $14 million lottery payout plus the $150,000 in interest from my year one deposit into a new chunk of treasuries. My $14 million from year one is still there. Assuming interest rates don’t change (they will change, but I don’t know what they will be a year from now), I would get 1.08% on $28,150,000. That would get me over $304,000 in interest. Add that to my year three deposit of $14 million, which gives me a total of $42,304,000 at 1.08%. Rinse and repeat.
In year ten and beyond, I get a bonus. Not only do I get my $14 million lottery payout, but the first block of 10-year treasury bills I purchased will mature and be redeemed. So I will also get a check for $14 million from the US government for redeeming the first block of US treasury bills I purchased. If I reinvest that into another block of 10-year treasury bills and the planned $14 million from the lottery winnings, that will be a $28 million block of treasuries purchased. Plus the interest from my year two-through-nine deposits, which is about $1,200,000 at this point. $29.2 million in total treasure bills. Those will spit out $315,360 a year in interest if interest rates on 10-year T-bills are still at a paltry 1.08%.
Moving forward, the next decade will have similar occurrences. Each year, the ten-year T-bills that I purchased a decade ago will mature, and I can then reinvest them along with the $14 million planned investment. And I am generating $315k per year in interest on top of that, which can be reinvested for a total of $29.5 million worth of treasuries.
In the third and final decade of lottery payouts, my $29.5 million blocks of T-bills will mature and can be reinvested along with a fresh $14 million for a total of $43.5 million worth of T-bills.
By the time the lottery stops paying me, I will have ten blocks of $43.5 million worth of treasury bills, each paying me about $470,000 in interest or $435 million of treasury bills paying $4.7 million per year in interest. It will hopefully be larger than that if long-term interest rates ever rise. Factoring inflation over the next 30 years will only feel like $2 million in today's dollars. Coincidentally, that is what I was keeping per year for spending from my lottery payout. Go figure!
We’ll continue to reinvest the principal as the bills get redeemed moving forward.
When my wife and I die, assuming we haven’t touched the principal, we can leave $435 million behind. I haven’t consulted with her yet, but I imagine we would leave most of it to charity. If our kids aren’t self-sufficient by then, then they don’t deserve the money.
Option 3 – Go Big
With the first two options, I have played it extremely safe and set up a plan to ensure the lifelong income of far greater amounts than we would ever really need to survive. Life will be damn good.
But hey, I just won the lottery. See if we can grow some of this money.
Using the same starting assumptions of taking the 30-year $33.33 million/year payout, giving half to charity, keeping $2 million for spending, and investing the remainder after taxes (about $14 million). If I invest that money every year into a diversified portfolio of low-cost mutual funds, assuming a long-term average rate of return of 7%/year, I would have $1.3 billion by year 30.
Could be more, could be less, every year will be a roller coaster. Investment returns are the opposite of guaranteed. Also, if taxes were factored in, the results would probably be a bit less.
Let’s say after taxes. I have $1 billion. I could buy a single premium immediate annuity and probably collect about $33 million/year for the rest of my life. In tomorrow dollars, so it would only feel like about $17 million. I think I would be OK. I could keep $4 million for spending (again, inflation has doubled the cost of living) and give the rest to charity. Pretty cool – I’m able to continue giving $13M a year to charity in “retirement.”
I could also keep the money invested in a diversified portfolio of stocks and bonds. Using a 4% safe withdrawal rate, I could probably collect over $50M/year without ever running out of money. If I only collected $4 million a year for living expenses, that $1.3 billion would likely turn into more than $5 billion by the time I die.
Maybe I’m not spending enough in this fantasy.
So There You Have It
If any of you win the lottery, give me a call so I can help you devise a plan to reach your goals and ensure you don’t run out of money. It doesn’t matter how much money you have. Financial problems don’t discriminate. They hate all of us equally. We need to ensure we develop a plan to keep us on the right track.
Lottery games are based on chance and should be played for entertainment purposes only. Investments involve the risk of loss, including total loss of principal.