Dear Powerball Winner: Take Our Advice and Take the Annuity

The New York Times reports:

there are big tax advantages to the annuity. The main one is that taking the annuity is basically like letting the government hold onto part of your prize for a while and invest it for you — and the government does not pay tax on investment income. Of course, once you get the annuity checks, you’ll have to pay income tax on them. But if you take the lump-sum cash prize, you’ll pay tax twice: on the prize when you win it, and on the income you get by investing it.

This adds up. If you invested all your prize money in the same way Powerball does (essentially by putting it in government bonds), you’d end up with 20 percent more cash in 2045 if you took the annuity option rather than the cash option, thanks to the tax savings. You could shave that difference by picking a different investment strategy with better tax management, but you’ll never beat the effective tax rate of zero on the investment income earned inside the Powerball annuity.

Taxes aside, you’ll probably quibble with the pretax rate of return on the Powerball annuity. Effectively, it’s like investing in bonds that pay 2.843 percent interest. But that’s actually a good deal for an ultrasafe investment in today’s ultralow interest rate environment, says Allison Schrager, a financial economist with expertise in annuities.

Ms. Schrager noted you’d pay big fees to an insurance company to build the same investment that Powerball is offering you, and because of those fees your effective interest rate would be even lower than 2.843 percent. As annuities go, this one is structured very favorably. You can even leave it to your children if you die before you finish collecting the payments.

A problem many would like to encounter.