[Note: This article was originally posted on May 23, 2013.]
There’s one person – or maybe a group of people – who has yet to claim the largest Powerball jackpot in history: an estimated $590.5 million.
The ticket was purchased on May 18 from a Publix supermarket in Zephyrhills, Florida. The winner has 60 days to claim the lump-sum cash option – estimated to be around $376.9 million – at the Florida Lottery office in Tallahassee.
Under Florida law, lottery winners in the state cannot remain anonymous; their names and city of residence must be made publicly available to anyone who asks. As of the morning of May 22, the Powerball winner has not yet surfaced.
So what if that person or group of people came to your firm before the prize was claimed and asked for advice on how to manage and invest his/her/their winnings? What would you say?
AccountingWEB spoke with five professionals from four accounting and wealth management firms, who offered 10 tips on what they would tell the Powerball winner(s). Those interviewed include:
- Mira Finé, CPA, national director of tax operations, Hein & Associates LLP, Denver
- Scott Hitchcock, director of wealth management, McGladrey Wealth Management LLC, Seattle
- Rob Keasal, CPA, tax partner, Peterson Sullivan LLP, Seattle
- Kathy Scorcio, director of wealth management, McGladrey Wealth Management LLC, Tacoma, Washington
- Ken Travis, CPA, partner, TravisWolff LLP, Dallas
1. Hire a strong professional team. This group should include any one or all of the following:
- A financial advisor who can help walk you through the initial stages of what you should do, how to claim the prize, and how to manage your portfolio.
- A CPA or an independent accountant who has experience working with high-net-worth clients.
- A tax/estate attorney to assist in asset protection and estate planning.
- A financial planner who can model cash-flow planning.
“When you hire an advisor, make sure it’s someone you’re comfortable with because you’re going to be working with that person for a long time,” Hitchcock said. “You want to be working with someone who you can have honest conversations with because your life just changed significantly.”
Finé added, “Do your homework ahead of time, and don’t shortcut the search for a financial advisor.”
2. Decide on taking the lump sum or an annuity. Several factors play into this decision, both Keasal and Scorcio said.
“With that amount of money and the earnings you would have off that money, even if you took the lump sum, you’re going to be in the highest tax bracket for a very long time,” Keasal said. “It’s a matter of deciding whether you’re going to make more money with your investment advisors than what the annuity is going to pay. Investment advisors usually do better than what the assumed rate of return is on the annuity.”
Scorcio added, “This is definitely an area an accountant can help you with, because you want to take into consideration what future tax rates might be. You may be better off taking it as a lump sum. What’s the discount rate on the present value of annuity that took place at the time? That’s an analysis process you want to go through. Your answer might end up being different from what you first thought.”
3. Learn how to say no. Once the name of the Powerball winner is announced, he or she is going to be inundated with messages from long-lost family members, friends from grade school, and others asking for money.
“Having the discipline to say no to these requests will be a critical near-term skill. There will be plenty of time for careful review of quality requests,” Travis said.
Scorcio added that a McGladrey client who won a large lottery several years ago is still receiving requests for money.
“Here we are eight or nine years later, and our client is still getting letters from people wanting money. It doesn’t stop,” she said.
4. Make sure all taxes associated with the earnings are paid. Because these aren’t tax-free winnings, the Powerball winner will need the ability to pay the tax liability, said Hitchcock. The withholdings from the lottery are usually not sufficient enough to pay the tax liability.
“The withholdings don’t necessarily equate to the total taxes, including state taxes,” Finé said.
In the state of Florida, taxes are withheld on lottery winnings of $600 or more, according to the Florida Lottery website. For prizes of more than $5,000, US citizens and resident aliens with a Social Security number are subject to a 25 percent deduction to their prizes, which represents federal taxes. Lottery prizes are exempt from Florida state and local personal income taxes.
For example, the estimated Powerball jackpot on May 22 is $40 million. For the lump-sum option, the winner would receive $25.1 million. Federal tax of 25 percent ($6.275 million) is required to be withheld. After withholding, the winner gets a net lump-sum payment of $18.825 million. Currently, the maximum federal income tax rate is 39.6 percent, so additional federal tax up to 14.6 percent is likely to apply, as well as state taxes depending on where the taxpayer lives.
For the annuity option of $40 million, the winner would be paid in 30 annual payments in the average amount of $1,333,333.33 per year. The average federal tax liability would be $333,333.33 per year. The average net lump-sum payment after tax withholding would be $1 million per year.
5. Park your money in a safe location. Scorcio recommends that the lottery winner put his or her money in a brokerage account or invest it in short-term treasury bills until an investment plan is in place and ready to be executed. Both she and Hitchcock recommend against depositing the winnings at a bank.
“Most of the winnings would not be FDIC insured,” Hitchcock said. “In the past five to six years, we’ve seen a number of bank failures, so you don’t want to park that $200 million or $300 million at a bank because it doesn’t give you enough protection. Brokerage accounts, for example, have to be segregated from the brokerage firm’s assets. If the brokerage firm were to fail, creditors can’t go after your securities. Whereas at a bank, your assets are commingled with the bank’s assets.”
Finé recommended having a limited liability company (LLC) as the named holder of the funds.
“This helps because a separate name is listed on collection – less harassment from outsiders and family – and the LLC protects the collectible cash,” she said. “You also may want to consider placing your other assets in an LLC to protect the cash from liabilities associated with your other assets, which can include your personal residence.”
6. Don’t make financial decisions too quickly. The most frequent error TravisWolff advisors see with sudden-wealth recipients is they make many financial decisions too quickly.
“You don’t have to make huge gifts, buy expensive houses, or commit to irrevocable legal or investment strategies in the first year – or ever,” Travis said. “Learn what it feels like to have a different economic status – and it can take a few years – then consider what steps make the most sense for you and your family. It’s rare to get two chances to be rich, so careful planning, quality advice, and prudent decisions will allow you to stay rich and enjoy it.”
Scorcio said her advice to anyone who has a significant financial or emotional event in his or her life is to wait up to a year before making any important financial decisions.
“You don’t want to immediately go out and sell your house and move someplace else and do all those things right away,” she added. “You want to have time for the whole experience to percolate. Give yourself plenty of time to figure out what you really want.”
7. Start a health savings account. Now that the new lottery winner will be able to pay for just about anything, Keasal recommended that he or she buy a high-deductible health plan and invest in and fund a health savings account.
“As a family, you can put $6,450 away each year. If you don’t spend all the money in your health savings account, it rolls over to the following year and earns interest. You can let it build up and use it for medical expenses far out into the future, tax-free,” he said.
8. Be careful not to harm your family or charities with the size of gifts. While giving money to a family member, friend, or charitable organization is seen as an unselfish gesture, it could do more harm than good if not dealt with in a thoughtful manner.
“Wealth is ultimately a responsibility,” Travis said. “How can it add meaning to your life and the lives of those around you? What impact does wealth have on your children? Your community? Without a long-term view, wealth can sometimes cause more problems than it solves.”
For example, say a lottery winner wants to buy his brother a million-dollar house. Has he thought about whether his brother can maintain the house or pay the real-estate taxes on the house?
“Those are the decisions you need to think about beyond ‘I’m going to give this person some money.’ You need to think about what effect that money will have on the person’s life,” Scorcio said.
The same mind-set should apply when making a charitable donation, according to Hitchcock.
“For example, if you drop a $3 million charitable gift to the local food pantry, it’s just going to overwhelm them. They’re not capable of handling it, whereas the American Cancer Society can handle a larger gift because it’s a much larger charity,” he said. “So match the gift to the charity. If you’ve set aside $250,000 for charities, set up an endowment fund that allows for an annual payment to that charity, but isn’t a huge lump sum.”
Another factor Hitchcock said to keep in mind is to decide how you want to give.
“If you want to remain anonymous, you may want to run the gift through a donor-advised fund, where you can make the contribution and then recommend to that fund how you’d like to make charitable gifts and to whom,” he added. “There’s a barrier between you and the charity.”
Another charitable avenue a lottery winner can take is to set up 529 plans for their children or grandchildren, Keasal said.
“Those plans would earn tax-free income as long as that money is used to pay college expenses,” he stated.
9. Understand how your advisors are getting paid. When developing an investment plan, Hitchcock offered three pieces of advice: keep it simple; keep it straightforward; and, maybe most importantly, know how your advisors are getting paid.
“Everybody gets paid. In the investment world, advisors can receive a commission, they can get paid on a transaction-type basis, they can get charged a wrap fee on your investments, or they can get paid on a fee-only basis,” he said. “One isn’t necessarily better than the others. We recommend a fee-type structure because that’s how we operate, but that’s up to your advisor and how they operate.”
10. Splurge on yourself - but don't go overboard. What’s the fun of having a lot of money if you can’t spend it? Travis said the Powerball winner should develop a short-term plan for immediate “I wants.”
“Almost everyone has given this a little thought, so have some fun – but use your head,” he added.
Hitchcock noted that the McGladrey clients who won the lottery didn’t allow their newfound wealth to significantly change their lifestyle.
“They bought a new house, but it was a very modest-looking house in their neighborhood,” he said. “They bought a 16-foot runabout-type fishing boat, and a Ford Ranger pickup truck to tow it. Nothing wild.”
Hitchcock recommends setting a spending budget in the first year – and sticking to it.
“Maybe make it a half a million dollars the first year,” he stated. “Don’t go overboard, and don’t make any huge, long-term commitments.”