The decision of a lottery winner to either take the lump sum money or take an annuity i.e. money spaced out over a period of years will depend on several factors key among them being the impact of income tax. However, putting aside the matter of tax as it will be charged in either style of the payment, other factors which could be considered include the winner’s debt level. A winner with a lot of debts will opt for the lump sum where he or she can clear the debt first before embarking on how to spend or invest the money. Another reason which might influence a person to take the lump sum payoff will be if they know how to get a reasonable return from investing the money (Hickey, 2013). For cautious spenders who do not want to squander the money will choose an annuity pay off style. This payoff style is further strengthened with the winners’ knowledge of expected return. Other factors which will be considered are what the winner other than investing the money, wants to do with the money. One might choose to support a charity or out rightly spend the money on lavish things hence favoring the lump sum payoff style.
Assuming that a rational winner will either choose to put the money in a bank or invest it in the market, one will have to consider either the lump sum and put it in an investment account or consider the annuity payoff and invest every payment received. Assuming that the amount won is $100000 and the investment bank offers an investment program at different rates and for different durations for fixed deposits how will this knowledge affect the winner? For an annuity payoff, the winner stands to receive $10,000 every year for 10 years. The formula for determining the future value of the annuity is the (Annuity amount * FVAIF) (Carther, 2016).
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C=10000, n 10years, I ranges between 0% and 10%
The formula for determining the future value of a fixed amount at its present value *FVIF
PV=100000, n= 10Years, I range between 0% to 10%
| Return | present value *FVIF | Lump sum | Annuity * FVAIF | Annuity |
| 0% | 100,000 | 100000 | ||
| 1% | 100000*1.1046 | 110460 | 10000*10.4622 | 104622 |
| 2% | 100000*1.2190 | 121900 | 10000*10.9497 | 109497 |
| 3% | 100000*1.3439 | 134390 | 10000*11.4639 | 114639 |
| 4% | 100000*1.4802 | 148020 | 10000*12.0061 | 120061 |
| 5% | 100000*1.6289 | 162890 | 10000*12.5779 | 125779 |
| 6% | 100000*1.7908 | 179080 | 10000*13.1808 | 131808 |
| 7% | 100000*1.9672 | 196720 | 10000*13.8164 | 138164 |
| 8% | 100000*2.1589 | 215890 | 10000*14.4866 | 144866 |
| 9% | 100000*2.3674 | 236740 | 10000*15.1929 | 151929 |
| 10% |
100000*2.5937 |
259370 | 10000*15.9374 | 159374 |
From the above analysis, at every level of interest rate beyond 1%, it is more profitable to take the lump sum amount and invest it rather than taking an annuity payment style. I would choose the lump sum payment style.
References
Hickey, W (2013). Lump Sum Or The Annuity: Here's Which One to Choose If You Win the Lottery . Retrieved from http://www.businessinsider.com/should-you-take-the-annuity-or-the-lump-sum-if-you-win-the-lottery-2013-9
Carther, S (2016) Calculating the Present and Future Value Of Annuities. Retrieved from http://www.investopedia.com/articles/03/101503.asp
