The biggest single-winner payout in the lottery was the $1.537 billion Mega Millions jackpot. Winning this amount from the lottery is probably the most significant overnight change that a person could go through. But more than the amount, can you imagine the taxes that you have to pay every year if you’re the lucky winner?
All winnings from the lottery are subject to tax, but it’s not as simple as paying for it the year you won. If you take its annuity value, you’ll have to pay taxes every year. It’s simpler when compared to taking the lump sum and investing most of it to generate taxable income every year.
Paying taxes on lottery winnings sounds simple, but it’s a smidge more complicated. If you’re not careful with how you handle your winnings, you’ll spend most of it on taxes. Stick around to learn more about it, and we’ll even share with you some of the things that you can do to increase your take-home winnings legally.
Ways to Receive Lottery Winnings
Whether you’re playing Powerball or Mega Millions, you’ll have the option to choose between taking the annuity value or a lump sum payment. The annuity value is the amount that the lotteries advertise, but it’s actually the total amount you could receive over 30 years. If you win the lottery, you can opt to take a one-time lump sum, which is much lower because it’s adjusted for inflation and interest rates.
For context, remember the $1.537 billion Mega Millions jackpot on October 23, 2018? The winner chose the lump sum for it and only received $877,784,124 before taxes. Well, $878 million isn’t a small amount, but that is almost half of the annuity value that they advertised. It’s not really that bad, though, because experts, including “Shark Tank” investor Kevin O’Leary, advise people to take the lump sum.
According to O’Leary, taking the annuity value of the winnings will subject you to yearly taxes. Aside from that, you’re also paying without any flexibility or tax breaks. You’re apt to get more out of it if you invest your money in low volatility dividend-paying stocks. After that, you get to pay yourself the annuity, which will end up higher than if you were to take the annuity value of your winnings.
Even if you generate taxable income from it every year, it will still be less than the amount that you owe the IRS. However, it doesn’t mean that taking the annuity payments is terrible because you always get fixed annual increases on your winnings and spread out through 30 years. If you’re the lucky winner of the $1.537 billion, and you’re not sure how you can make the lump sum grow by $659,216,876 within 30 years, then taking the annuity payment is a better option.
These metrics are essential to this topic because the method on how you receive your lottery winnings is the most significant factor that affects your taxes. Whether you’re taking the annuity value or the lump sum, you’ll need to pay taxes every year. It’s the same in any type of income, but the difference between the two is how much you’re paying the IRS annually.
Paying Taxes on Lottery Winnings
The IRS puts lottery winnings on the top income bracket with a 39.5% tax rate. It’s a flat-rate, whether you win a thousand dollars or a billion dollars. The government will withhold 25% of the total amount before it even reaches your hands. You’ll have the remainder of the year to invest whatever amount you received to generate income, then pay the remaining 14.5% by tax time.
That’s not everything there is to taxes, though, because 39.5% is just the federal tax. In the US, there are only seven states that don’t impose income tax on its residents: Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming. The remaining states will take a chunk of your winnings, with California having the highest state tax at 13.3%. That’s on top of the federal tax, and we’re not even taking into account the municipal tax.
If you chose the $877,784,124 lump sum from the jackpot, the government would withhold a total of $219,446,031 from your winnings, leaving you with only $658,338,093 that is still subject to state tax and municipal tax. Not to mention the remaining $127,278,697.98 that you have to pay by tax season. That’s a considerable amount, but it’s not the worst that could happen when paying taxes on your lottery winnings.
If you chose the annuity value of your winnings, it’s not a guaranteed amount, but rather an estimated value of your winnings after that period. The only thing that we’re sure of is that it will be higher than the lump sum due to inflation and interest rates, but is also subject to higher taxes. Since it’s a type of income that comes from winning the lottery, it’ll always have the top income bracket when submitting your income tax return.
The taxes for the lump sum seems higher because you received all of your winnings at once, and you need to settle it that same year. Taking the annuity seems smaller, but in reality, it will be higher because you have to pay increasing amounts every year, and it will always be under the top income bracket in federal and state taxes.
If you are to take the lump sum, then invest it in a dividend-paying stock, you’ll have a huge tax bill on the year you won, but you’ll have better flexibility with the investments you make. The reason why a lot of experts advise winners to take the lump sum is that there are a lot of variables that come into play when choosing the annuity value. All of these variables can contribute to the actual value that you’re apt to receive from your winnings.
It’s true that you still have to pay taxes every year, whether you’re getting the annuity or the lump sum. However, taking the lump sum means that you only get taxed on your winnings for one year. The subsequent years will still have taxes, but it’s already on the investments that you’ve made using that money. It’s the same as any type of income you generate, but investing gives you better flexibility and more tax breaks options.
How Much Tax Do You Have to Pay?
Regardless of whether you took the lump sum or annuity value from the lottery, the IRS will always consider it as taxable income. However, the amount that you have to pay varies on the type of payout that you chose, where you live, and the investments you’ve made using your winnings.
For example, if you chose the $877,784,124 lump sum from the biggest single-winner lottery jackpot, you need to pay $346,724,728.98 in federal taxes. If you chose the annuity value of $1.537 billion, you could expect to pay around $607,115,000 over 30 years. That’s already about twice the difference, and it’s just for the federal tax. You still have to take out a substantial amount for the state and municipal taxes.
The state taxes that you have to pay on top of the federal tax varies, depending on where you live. Most of the US states use a progressive income tax system, which increases your percentage as your income grows. However, it does very little for lottery winners because lottery winnings are always in the highest income bracket, regardless of the amount.
To help you understand the taxes that each state charges, here’s a table of all the states that use progressive tax rates:
All States That Use a Progressive Income Tax System
|State||Min. Tax||Max. Tax|
|District of Columbia||4%||8.95%|
Aside from Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming, all states place a tax on all types of income, whether through personal income or lottery winnings. However, money earned from the lottery always has the highest tax bracket in most states. That’s why taking the annuity value of your winnings will always result in a much higher tax percentage.
Powerball has a minimum jackpot of $12 million, and Mega Millions has a minimum jackpot of $40 million, which puts both on top of the tax bracket. But even if you only win low prizes, $10,000, for example, your state will still put it on the highest income bracket. With that in mind, the only way for you to legally minimize the taxes that you have to pay is to live in states with low tax percentages.
Here are the states where you’ll have to pay the lowest taxes on lottery winnings:
Top 10 States with the Lowest State Taxes
Obviously, living in a state without an income tax is a much better option for lottery winners, but the states above are also good for lottery players. For comparison, here are the least friendly states when it comes to taxes on lottery winnings:
Top 10 States with the Highest State Taxes
With all of these tax rates in play, a winner from North Dakota has a much larger take-home pay from the lottery, than someone who lives in California. However, there’s another tax that you still have to consider when paying your taxes—municipal tax.
Cities and towns may also charge taxes on property, fuel, sales, and corporate and personal income, including lottery winnings. It’s another factor that could have a significant impact on the amount of taxes that you have to pay. For example, San Bernardino, California, has a municipal tax rate of 8% on top of the staggering 13.3% state tax.
That means, whatever amount you received from the lottery, 39.5% goes straight to federal tax. If you’re living in San Bernardino, California, you’ll have to spend another 21.3% on state and municipal taxes. If you’re taking the annuity payments from the lottery, you can expect that this is the amount of tax you’ll have to settle every year.
It’ll be the same for the lump sum, but only for the first year. Even if you use more than half of your winnings to pay taxes and invest 100% of what’s left, you can still expect to pay less in taxes. That’s because the income that you generate from various investments will have a lower tax bracket. You still have to pay taxes every year, but strategizing gives you better returns and lower taxes rather than to hope that your lottery “pension” performs better next year.
How Often Do You Pay Taxes on Lottery Winnings?
Going back to your original question: do you really have to pay taxes on lottery winnings every year? The short answer is yes. You have to pay taxes every year, but it’s not as simple as you might think. If you take the annuity value of your winnings, you’ll pay the tax on the year you received a payment. That would be every year for 30 years, and every payout you received will have the same top income bracket rates.
For the lump sum payout, you’ll receive a much lower amount, but you only have to pay for “that” income on the year that you received it. Any profit you generate from the properties you bought, the investments you made, and other commodities using that money will still be taxable every year. However, it’ll be on a much lower tax bracket, and some states even offer tax breaks on different investments.
For the sake of comparison, let’s say that you used 100% of your lump sum for investments to generate income for years. That would mean you’ll have to pay the taxes for all of your generated income using your lottery winnings. There’s nothing wrong with it, and is the same, regardless of how you’ve made the money you used for your investments.
If you take the annuity value, your income tax bracket will be the same throughout the period, and it’ll always be the highest. With a growing annual income from the lottery, your taxable income grows without flexibility and an option for tax breaks. Whether you’re getting $30,000 or $30 million per year from the lottery’s annuity payments, you’ll always have the top income tax bracket. There’s no legal way for you to minimize the taxes that you have to pay.
It’ll always be 39.5% for federal tax, your state’s top income tax bracket, and your municipal income tax percentage. So, despite having a much higher value at a glance, a winner who takes an annuity pay may not really have that much benefit from it.
On the other hand, if you diversify your lump sum, you’ll still have to pay taxes yearly, but it’ll be from various investment vehicles that you choose. In many states, there are varying tax breaks for investments with a much lower tax percentage on the income generated from it. So, even if you’re paying taxes yearly, you’ll have better flexibility with the amount of taxes that you have to settle.
That’s the reason why a lot of experts always advise people to take the lump sum whenever they win the lottery. However, if you’re not sure about what investments you make or worry that you may not have the same return on your money if you were to invest your winnings, it’d be better for you to take the annuity value of your winnings.
Winning the jackpot in the lottery may have a 1:302,575,350 (or 1:292,201,338 for Powerball) probability ratio, but taxes will always be 1:1. If you make money, regardless of the method on how you’ve made it, you need to pay your taxes. The federal, state and city governments will take a considerable percentage out of all your winnings, but there’s a way to minimize it in a proper, more rewarding way.
Take the lump sum and use it to create a diversified portfolio that allows you to receive more tax breaks and dividends. Even though you’ll still have to pay taxes every year from the income that your investments generate, it’ll still be less compared with the taxes you have to settle if you choose the annuity value.