The Big Game Lottery - an Opportunity Superior Jackpot Gives People - Case Study Example

The Big Game Lottery Name Course Tutor Date Larry and Nancy Ross of Shelby Township, Michigan and Sue Kainz of Lake County, Illinois are the lucky winners of the big game lottery, they are Lucky guys but Now here comes the hard part. Lump sum Or Annuity Taking a look at the point where to care about the big game lottery putting into consideration the relationship between partaking and the size of the jackpot, the big question is what happens in reality when you win? The answer would appear to be “receive the whole amount of money immediately and afterwards spend every coinage on playful crap.” However supposing someone won the lottery and then he or she tried to handle it as rationale as possible? Financial advisors would advise the winners who won the jackpot (Walter np). The major question one would like to know whether an individual who hit the jackpot would opt to take the cash or opt to take the annuity option which would consist of more money spread out over a period several years. First and foremost before making a decision on which mode of payment to take, one must understand the impact of taxes. Taking into consideration the lump sum of the lottery, the receiver will be in upper limit income tax bracket regardless whether they take the cash option or annuity (Walter np). The following considerations have to be put in place before one makes a decision. Less Money: If an individual chooses the cash option, as opposed to the annuity option, one will be paid much less money than the jackpot’s face value. When one chooses the annuity option, the Michigan lottery takes the face value of the big game jackpot and invests in annuity or bonds which eventually generate interest that will fund the future payments. When an individual chooses the cash option one receives about 50% of the advertised value of the jackpot. In this case the winners would receive approximately $90.75 million in lump sum or take $6.98million annually for 26 years and receive the entire $181.5 million (Herb np). Investment Savvy: Michigan lottery say that if you win the big game it is fair to go for the cash option since when invested wisely, one can at last get the face value of the jackpot. On the other hand, Michigan lottery will invest the whole present value of the big game jackpot and the winner can only be in a position to invest the after-tax sum. As a result for the winner to match the Michigan lottery’s disbursement installment, one would have to be in a position to attract a considerably higher investment return on your cash than the Michigan lottery (Herb np). Tax Effects: In the event one takes the cash option, you will have to pay taxes on the lump-sum amount in that year you are paid. This financial breakthrough will most likely push one upwards in the tax bracket. Taking annuity spreading them over several years will translate to one paying taxes to the amount paid annually. The consequence of this is more after-tax cash if you opt for the lump sum (Herb np). Money Management: The money management abilities of the winner will affect the decision on whether to go the lump sum or annuity way. There have always been many stories from lottery of people who misused their jackpot cash over a few years and they end up worse than they were before winning the jackpot. By taking the annuity option, the mistakes that one make usually are limited to that current year. The installments provide one with an opportunity to learn from previous mistakes and improve on the following year’s installment. When one misuses the lump sum, there is no second chance to improve on your management of the cash (Herb np). Considerations: One’s age may also play a big role in making the decision. A young person would opt to take the annuity option and the installments would provide a financial foundation for one’s lifestyle or business in contrast to an old person who would go for the lump sum and be liberated from any worries of money for the reaming years. The Michigan lottery has a guarantee that if a person chooses annuity and he dies before the final payments, his beneficiary will receive the remaining installments (Herb np) Putting into consideration the above factors, I would choose the annuity option. Taking into consideration the large amount of the big game lottery prize, the winners will fall into the highest income tax bracket once they receive the payment no matter whether they take the cash option or annuity over 26 years, but the big question is whether there will be any tax changes over the subsequent years. The federal tax is 28% and state tax of 4.8%. Tax rates are always changing, if the winners take lump sum they will incur a federal tax of 28% and state tax of 4.8%. If the winners take annuity of 26 years, most likely the tax rates will be different when each payment is received (Blake np). Majority of winners who would expect the top tax rate to reduce with time should take the annuity whereas those who think there is a probability of tax rate increasing in the end should opt for the lump sum so as to get everything off the beaten path sooner. Provided the tax rate does not vary in the next 26 years, there would be no difference in the effectual tax rate one has to pay on all the winnings (Walter np). Larry and Nancy of Michigan won a combined amount of $181.5 million which translates to $ 130,680,000 after retention of 28% federal tax and $124,407,360 after 4.8% state tax retention the annuity option would be annual payment of $4,784,898 plus an additional of 5% interest $4,784,898*0.05 = $239,244 = $4,784,898 + $239,244 = $5,024,142 paid annually for 26 years The total amount that will be received in annuity will be $130,627,692 after 26 years. (Walter np) Since most winners want to control their entire amount immediately, they decide to take the lump sum. There possibly will be a tax edge by opting to go for the lump sum, since a good number of experts have a strong believe that there is a possibility in future the tax rates will increase as the United States attempt to cut down its deficit (Jill np). The chart below clearly shows what happens when a winner invests his winnings at an interest rate between 0% - 10 % the green lines represent the lump sum investment when all the winning was invested at once after the initial tax. The red lines represent the annuity investments after the post tax once received each year. Table1Table showing the return on investment done on lump sum and annuity payments According to the above when lump sum investment gives more returns as opposed to the investment made on each payment done annually on annuity, this makes more winners take the lump sum amount. (Walter np) There have been studies that have taken an approach to estimate the price elasticity by applying a method called “effective price”. This (effective price) is the variation between the lottery ticket face value and the value expected. Demand for lottery is dependent on the effective price and other variables. Effective price in turn depends on the ticket’s expected value which is mainly influenced by sales’ volumes. The face value of the jackpot has an influence on the demand of the lottery (Forrest, Simmons and Chesters 487). The basis of his is the idea that individuals are “purchasing a dream”, superior jackpot gives people an opportunity to purchase a bigger and a better dream. This proves why Michigan is justified to advertise for the face value of the jackpot.( NERA np) Works Cited Blake E., You won the lottery! What's your tax hit?. November 30, 2012. web 22nd may 2014 Forrest, Simmons and Chester (2002), Buying a dream: alternative models of demand for lotto, Economic Inquiry, 40: 485-496 Herb Kirchhof, Lottery Annuity vs. Lump Sum. Zacks Investment Research, Web 22nd may 2014 Jill Schlesinger, Powerball dilemma: Lump sum or annuity? March 27, 2013 . Web < http://www.cbsnews.com/news/powerball-dilemma-lump-sum-or-annuity/> 22nd may 2014 NERA, Economic Consulting Assessment of Lottery Market Issues 17 April 2012 web < https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/78198/NERA_lottery_research.pdf> 22nd may 2014 Walter Hickey, lump sum or the annuity: Here's Which One To Choose If You Win The Lottery, web 22nd may 2014 Read More