Despite the terrible odds — you just won the lottery! You’re likely in shock, disbelief, and just overwhelmed with emotions or maybe you’re already excited to go into work to quit your job, but before you do anything, you’re likely asking yourself, “now what?”
Lottery officials recommend winners take a deep breath, put their winning ticket in a safe spot and consult with a reputable financial planner before popping over to the lottery headquarters. Your first major decision after winning the lottery will be whether to take the lump sum cash option or the annuity option. The lump sum will give you all the cash up front while the annuity options gives you one initial payment and annual installment payments over 29 years. Nearly all winners opt for cash, but the annuity has advantages, as it reduces the tax bill a little and offers a stable flow of income that climbs by 5 percent annually.
And that brings us to our next points, Taxes. Taxes have been the Achilles heel for many lottery winners and can really hurt your wallet if you’re not careful. For instance, the IRS can tax you up to 37% on your winnings. Then, for winners of $5,000 or more, all states automatically deduct 24 percent in federal taxes, but state taxes vary widely. Some big states, including California, don’t withhold taxes from lottery winnings, and some like Texas don’t have individual income taxes at all. For the others, the state takes a bite, especially in New York, where a winner would need to pay a state tax of 8.8 percent. Residents of New York City would pay an additional tax of 3.9 percent. In general, taxes eat up nearly half of winnings.
Winners of a large lottery, like Mega Millions or Power Ball, should realize that while taxes are initially withheld when the jackpot is rewarded, more money will be due when it comes time to file the tax return. This has to do with the fact most winners will now find themselves in the 37 percent bracket, a new place they had never been before. This new tax bracket also means higher taxation and a lower ability to claim tax credits and tax deductions. So keep in mind, if you win the lottery, don’t just be prepared to pay taxes up front, be ready to pay again in April.