I have another reason for President Trump to be mad at the Federal Reserve: Its recent actions have pushed down the value of Tuesday’s big Mega Millions jackpot.
The drawing is forecast to have the highest headline jackpot ever for an American lottery: $1.6 billion, which would just exceed the $1.586 billion Powerball drawing on January 13, 2016.
But that $1.586 billion prize — payable in annual installments over 30 years — came with an up-front cash option of $983 million. If you take the cash on Tuesday’s Mega Millions, you’ll have to settle for a mere $904 million, based on the lottery consortium’s estimates as of Monday afternoon.
How is this the Fed’s fault? Well, the cash option has gotten less rich because interest rates are higher today than they were in early 2016. It’s calculated by taking the 30 years of installment payments and “discounting” them to a present value by applying an interest rate based on the rates earned on government bonds. The higher bond rates are, the less a payment far in the future is deemed to be worth — and the less money the lottery needs to give you today to say it’s given you the up-front-cash-equivalent of $1.6 billion over 30 years.
Based on the projected payout schedule for tomorrow’s prize, that interest rate currently sits around 3.45 percent, up from 2.84 percent when I examined the big Powerball prize for the New York Times nearly three years ago. This is no surprise given the run-up in long-term interest rates, fueled in part by strong economic performance and in part by the Fed’s campaign of gradual short-term rate increases.
My advice to all of you prospective lottery winners remains the same as it was in 2016: If you win, decline the up-front cash and take the annuity.
The annuity comes with big tax advantages, because it’s like leaving your money with the government to invest on your behalf, and the government doesn’t pay tax on the investment returns. Of course, they’re effectively investing the money in Treasury bonds, which is why the annual returns are less than 4 percent, and that may seem low, but the rate is competitive with annuities you might buy from financial institutions, says economist Allison Schrager. And the tax-sheltered structure means you’d have about 20 percent more money after 30 years than if you tried to replicate this investing strategy on your own.
Perhaps more importantly than the tax advantages, the annuity provides insurance against yourself. Let’s be honest: If you’re buying lottery tickets, maybe you are not a financial genius. Tying up your money in a stream of 30 large annual installments will help you remain rich AF for the rest of your life, no matter what dumb consumption choices you make this year or next year or seven years from now.
“A billion dollars is hard to blow, but still, some people can blow a lot of money,” says Schrager.
Plus, when every person you’ve ever met in your life starts hitting you up for money, it will be helpful to be able to say your first installment payment was a mere $26 million and you already spent a lot of it.