Wednesday, January 13, 2016

Powerball Madness

The NYTimes weighs in here on the vital question of whether one should take the lump sum or the annuity if one wins the $1.5 billion PowerBall jackpot on Wednesday. Demonstrating the Times' usual blind faith in government fulfilling the promises it makes, the author advocates for taking the annuity.  Admittedly, if you take the lump sum you get an immediate $1 billion haircut, counting the income taxes, and that is hard to make up.  That's painful.

But the author naively ignores the effect of estate taxes.  Unless the winner is in his 20s, there is a very good chance of dying before the annuity is fully paid off.   The remaining payments may be discounted to present value, but that figure is then taxed and the tax must be paid within nine months.

Think of it this way.   Assume that the winner takes his first $50 million annuity payment and is hit by drunk driver and dies in 2106.  The taxable value of the remaining payments will be roughly $900 million, so a federal estate tax of $360 million will be immediately payable.  Where will that money come from?  Let's say the feds agree to take the $50 million annual payments until the estate tax obligation is paid off.  That delay will trigger penalties and interest, which will also have to come out of the annuity payments.

Will the heirs ever receive a dime?  Or does the federal estate tax effectively turn the prize from a term certain annuity to one that disappears at the death of the winner?

A surprising number of commenters to the Times article were aware of this issue, which the author was not. By "surprising number" I mean "any."

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