Is $1.5B Lotto Winner Better Off Under New Tax Law?

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Is the $1.5 Billion Lottery Winner Better Off Under New Tax Law?

Comparing the payouts under old tax laws and the Tax Cut and Jobs Act could be an eye-opening exercise for the rest of us.

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Sometimes luck works in your favor and other times, not so much. Both extremes were on display during October as investors witnessed a 10% pullback in their investments, while one ultra, super-duper, infinitesimally, lucky individual won the Mega Millions lottery worth $1,537,000,000 (that’s a billion and a half dollars for those of you who get lost in the zeros like I do).

SEE ALSO: New Tax Law 2018: Test Your Tax Smarts

I know, it’s hard to comprehend how big that number is. So what could a person buy with $1.5 billion? It’s an impressive list: an NFL team, four Boeing 747s, or even Buckingham Palace, if it were to come on the market. Crazy, right?

What You See Is Not What You Get

A $1.5 billion jackpot makes for a good headline, but that’s not the actual payment the winner receives. In order to collect $1.5 billion, the winner must select the annuity payment option, which is paid out over 30 years. The first annual payment starts out at approximately $23 million, and each future payment increases by 5%. By the 30th year, the payment grows all the way to about $94 million.

While the windfall of a 30-year annuity is certainly better than not, most winners instead elect a lump-sum payment to receive all the cash up front. This payment method cuts the $1.537 billion jackpot almost in half down to $877 million. Quite a difference, but still a good deal.

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What You See Is (Still) Not What You Get

An $877 million jackpot still makes for a good headline, but again, it’s not the actual payment the winner takes to the bank. Just as the sun rises every morning, both the federal and state governments take their cut of the winnings, and it isn’t a small slice of the pie. Assuming the South Carolina winner was married, the combined federal and state tax bill ends up totaling a whopping $386 million. That means the winner only takes home $491 million, which represents only 32% of the advertised $1.537 billion prize and 56% of the upfront $877 million cash payment. Ouch.

See Also: Taxes Are on Sale: Here’s How to Take Advantage

Did Tax Reform Make the Lottery Winnings Even Bigger?

Tax laws significantly changed as part of the Tax Cuts and Jobs Act of 2017, especially for individuals with lots of income and/or wealth. In the case of the lottery winner, three specific law changes created negative and positive impacts: The deduction for state and local income taxes, the changes to tax rates/brackets and the estate tax exemption.

In 2018, the state and local income tax (SALT) deduction is limited to $10,000, whereas in 2017 there was no limitation (unless you were paying the Alternative Minimum Tax). That’s a big deal since South Carolina’s tax bill for the lottery jackpot is about $64 million. In theory, the lotto winner lost a $64 million SALT deduction between 2017 and 2018. When it comes to tax, however, things aren’t always that simple. Additional limitations were in place in 2017 that reduced the total amount of itemized deductions by 3% of the winner’s adjusted gross income. Assuming the $64 million SALT payment was the only deduction, it would have been limited to approximately $35 million. At a 39.6% tax rate, the loss of this $35 million deduction would have increased the winner’s federal tax liability by about $14 million.

In 2018, the top tax rate is 37%, whereas in 2017 it was 39.6%. This 2.6 percentage point decrease in the tax rate, applied against $877 million of income, ends up saving the winner roughly $23 million in taxes. This benefit, even when offset with the change to the SALT deduction, makes the lotto winner a winner with tax reform, but only by $9 million.

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In 2018, the estate tax exemption increased from $5.49 million to $11.18 million per person. This increase of $11.38 million for a married couple would result in a tax savings of roughly $4.5 million if both winners had heart attacks upon the realization of holding the winning ticket.

Combined, all three law changes result in a tax savings of about $13.5 million by simply occurring in 2018. While in dollar terms this is certainly a lot of money, in relation to the total amount of wealth realized in the first year, it only represents a savings of 1.5% of the winnings.

What’s Next for Lottery Winner and You

The beauty of high-profile cases like this is there is much to learn from the decisions that are made and the insights we all can get from their successes and failures.

One immediate takeaway from the lottery winner is the importance of correctly timing your income when you can control it. The lottery winner is in control of when the ticket is redeemed and has a simple choice at this point: turn it in before or after the end of the year. While the winner is likely delaying coming forth to seek counsel from legal and tax experts, a big difference exists for when the income is incurred. If the $877 million payout occurs in 2018, the $386 million tax liability will be payable by April 15, 2019. Alternatively, if the ticket is redeemed in January 2019, the tax isn’t payable until a year later on April 15, 2020.

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That simple decision means that the winner can keep the $386 million in their name for an additional 12 months. Investing that amount of money at 2.5% — which is the rate on a 1-year CD, should the winner choose to go that route — would yield almost $10 million of interest.

For the rest of us, we have control over many types of income: distributions from IRA accounts, realizing capital gains on investments, deferring bonuses and income, exercising stock options, etc. The timing of these decisions matters and needs to be considered as part of a thoughtful strategy.

Money Buys A Lot, But Not Everything

Daydreaming about what your life would be like if you won the big lottery is certainly worth the price of at least one ticket, but winning is not guaranteed to buy you happiness. I’m certain it would initially buy a lot of happiness for you and those you love, but it would wane with time unless you understand the purpose, meaning and power of your wealth. Evaluating your priorities will allow you live better today and prepare yourself for a more satisfying future.

If major financial events are on your horizon, here are a few questions to ask your financial adviser or tax specialist in order to be prepared:

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  1. What am I doing to proactively prepare for potential major financial events?
  2. How would my life change if I inherited $1 million tomorrow? The answer likely guides changes you should consider today to live more in tune with yourself.

See Also: How 10 Types of Retirement Income Get Taxed

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Brian Vnak is Vice President, Wealth Enhancement Group, advising clients on income, gift, trust and estate tax issues.

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This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.