Whether checking out at your local supermarket, filling up with gas at the corner station, or watching your favorite TV show, you have likely been reminded of one of the most popular ways for consumers to test their luck: the lottery. According to a 2016 study from Gallup, nearly half of all Americans say they have played a state lottery in the past year. The attraction to purchasing a lottery ticket is obvious – a relatively effortless way to have a shot at winning an enormous jackpot. In fact, 2019 brought the third-largest lottery win in U.S. history with a $768.4 million Powerball jackpot and 2018 brought the largest ever at an outstanding $1.6 billion.
Here are some things to know about how the lottery works from a financial standpoint and what to consider if you are interested in playing.
Taking in taxes
State-run lotteries are currently operated in 45 of the 50 U.S. states, along with the District of Columbia, Puerto Rico, and the U.S. Virgin Islands. Though there is no lottery operated across the country at a federal level, many Americans will recognize two games that are indeed popular across the nation: Mega Millions and Powerball. These two games are run by independent, non-profit organizations of which most states are members. Powerball (run by the Multi-State Lottery Association) and Mega Millions (run by the Mega Millions Group) are separate entities but reached a cross-selling agreement in 2010 allowing their existing state members to sell both Powerball and Mega Millions tickets.
The benefit for states to be involved in lottery games is clear: tax revenue. States are able to collect an enormous amount of tax revenue if a winning ticket is bought and claimed in their state, which feeds into budget areas determined by state legislation. For example, ABC News points out that Texas has contributed $22 billion of lottery winnings to public education since 1997, Pennsylvania has dedicated $28 billion to senior resident programs since 1972, and Colorado indicates they use the funds to preserve local wildlife and parks.
Despite the state benefit, the federal government takes the largest chunk of jackpot winnings. To start, all winnings over $5,000 are subject to tax withholding by lottery agencies at a 25 percent rate. Depending on the winner’s tax bracket and size of winnings, that can swell to a total of 37 percent. Consider these tax rates on the Powerball jackpot from 2019. The winner from Wisconsin elected to take the $477 million lump sum cash prize and was required to pay out nearly $213 million in federal and state tax. Known nation-wide as a chance to win $768.4 million, the winner only brought home a total prize of about $264 million.
Payout options After hitting the jackpot, lottery winners have a crucial decision to make about how they receive their money. Payouts can be received in either lump-sum or annuity form, with pros and cons to each. Lump sum, which is the most popular method of payout chosen by jackpot winners, immediately gives you the full pile of cash after taxes, allowing the winner to do with it as they please. Many take the lump sum due to the possibility of growing that money through investments and to lock in their tax rate as it sits today. This option comes with a high degree of risk and requires discipline to pull off. According to the Consumer Financial Protection Bureau, nearly one-third of lottery winners eventually declare bankruptcy. Additionally, a study from The Review of Economics and Statistics found that 70 percent of Florida jackpot winners had spent their entire winnings within five years. The safer, less flashy option is to receive a series of payments through an annuity. These payments are locked-in with winnings being distributed over the course of 26 years for Mega Millions winnings and 30 years for Powerball winnings. This option also means that winners cannot opt to get a larger sum of money from their annuity in case of an emergency. Thankfully, winnings are contractually protected and will continue to be paid to beneficiaries in the case of the winner’s death
Stacked odds Although the appeal of winning the lottery is enticing, it is important to understand just how unlikely a jackpot win truly is. For example, this year’s $768.4 million Powerball jackpot had odds of one in 292.2 million according to the AP, while 2018’s historic $1.6 billion Mega Millions jackpot had odds of about one to 302 million according to NPR. When jackpots swell to numbers that large, we are often reminded of how the odds stack up against other wildly unlikely incidents. You are less likely to win a jackpot than get killed by a vending machine, have identical quadruplets, get struck by lightning, or be diagnosed with the plague. While playing the lottery can be an entertaining experience, investors should be aware of the odds stacked against them and not let the spending impact other, more pertinent financial needs and goals.