Taxes and the Lottery Jackpot

Lottery jackpot

In most cases, you won’t win a Lottery jackpot. But if you do, it’s time to start dreaming—about a new house, car, college for kids or grandkids or perhaps a vacation. But remember, lottery formulas and tax collectors will take a bite out of your prize.

The jackpot for the Powerball and Mega Millions lottery games has been growing rapidly in recent years. The current prize pool tops $1.8 billion, and if no one wins the drawing, the prize will grow even larger in the next draw. The eye-popping amounts are largely the result of better lottery odds and higher interest rates, which make annuity payouts —the alternative to lump sums —grow larger over decades.

But a larger annuity means more money for the winner over the long term, so lottery officials reduced the odds to keep jackpots from rolling over after too many drawings without a grand prize winner. That’s why jackpots are getting bigger and bigger, and how those big jackpots end up being smaller once you factor in taxes.

The most common type of lottery prize is a lump sum, which allows winners to choose to receive the full amount all at once or in annual payments over 29 years. The lump sum option is more popular, but federal income taxes slash the total by 24 percent, and state and local taxes may take even more. The lottery is a regressive activity, with disproportionately low-income Americans playing it: Those in the 21st through 60th percentile of income distribution tend to spend a greater share of their discretionary money on tickets than others.