There is still some confusion. What you describe as a deduction is actually a tax credit - a dollar for dollar reduction in the tax paid. A deduction reduces the amount of income subject to tax. Think of it as an allowable expense. Tax exempt income is never subject to tax. An exemption, like a dependency exemption, works the same way as a deduction.
My bad (that's what I get for posting in a hurry!). Thanks for catching that and correcting it before it got someone in trouble.
Brad, have you done a PV calculation on that annuity?
Haven't done a PV, but have done a FV calc on it. Here goes...
The calcs were done presuming the above figures - $100 mil jackpot.
Both figures use a 35% tax rate. For the 25 yr payout this means an actual take-home of $2.6 million pr year. For the single payout this means appx $39 million in a single lump sum (presuming the avg 60% jackpot payment amount for the single payment option).
It is presumed that the 25 yr payee will be investing half their annual payment and using the remainder for living expenses ($1.3 million). For sake of accurate comparison is it also presumed that the the single-sum payee will be using that same amount annually ($1.3 million) for living expenses, except that to have $1.3 million to spend
after income tax they will have to withdraw $2.0 million.
*DISCLAIMER* It's been a while since I was doing FV calcs. They may well be incorrect. Someone who's up to speed on a financial calculator please verify these!!
@ 5% interest
25 yr = $62.05 million
Single payment = $36.61 million
@ 6% interest
25 yr = $71.32 million
Single payment = $57.65 million
@ 7% interest
25 yr = $82.22 million
Single payment = $85.17 million
@ 8% interest
25 yr = $95.03 million
Single payment = $120.88 million
@ 9% interest
25 yr = $110.11 million
Single payment = $166.90 million
@ 10% interest
25 yr = $127.85 million
Single payment = $225.86
Spot Analysis...
If you know you are going to be able to sustain a minimum of at least 8% interest for the next 25 yrs, the single payment method will net you a higher value in 25 yrs. This presumes you are diligent in your spending habits and never draw more than $2 mil per year out of the portfolio.
If you are a conservative investor and budget-minded who tends to go with lower-yield (but less risky) ventures, the payout method will net you a higher value in 25 yrs. This also presumes you are diligent and contribute at least 1/2 of the annual payment to the account.
I tend to be very conservative in my finances. That's why the payout method has such an appeal for me. There is also the fact that many more conservative investments, although lower-yield, are potentially tax-free (municipal bonds, t-bills, etc). That's a built-in ROI due to
not losing 35% of the yield to income tax.
*Edited to add*
Now we get into all the ways you can use to step 'round the tax man if you opt for the 25 yr payout. There is a whole industry geared to giving those with the means a way to retain more of their dollars at the end of the year - set-asides, exclusions, deductions, deferments, exemptions, investments, etc. - none of which is an option for the person who takes the lump sum payout (on the jackpot winnings, not the interest income).
Presume that the payee of the 25-yr method finds a way for half their annual $1.3 mil investment ($650K) to fall into a category that exempts, defers, or otherwise removes the taxability for that portion of their income. At 35% income tax that's $227.5k recovered at the end of the year. Yes, you pay tax on the full $4 mil when it is paid but you get to recover a big chunk of it. Presume that you have enough willpower to reinvest that that $227.5k a year in the same account we were using above. The value of that extra investment would add to the above numbers as follows:
@ 5%
$10.86 million
(added to above 25 yr value = $72.61 million)
@ 6%
$12.48 million
(added to above 25 yr value = $83.8 million)
@ 7%
$14.39 million
(added to above 25 yr value = $96.61 million)
@ 8%
$16.63 million
(added to above 25 yr value = $111.66 million)
@ 9%
$19.27 million
(added to above 25 yr value = $129.38 million)
@ 10%
$22.37 million
(added to above 25 yr value = $150.22 million)
Spot Analyisis
Pretty much the same as above, except the percent return for a 25 yr net advantage has increase by appx 1.
I still prefer the payouts. I am a "structure" kind of guy, financially speaking. I still see more advantage to having a long-term payment plan that you can use to structure your finances around. Most of the tax deferment and exemption programs are structured around long-term revenue streams and not lump-sum windfalls (not surprising given that the programs were created by, and for, people with large, sustained revenue sources). I see there being many more opportunities for portfolio growth and management using the long-term payout vs the lump-sum payout.
Again, just my personal opinion.
(Side effects of this program may include fatigue, headache, dry mouth, nausea, hair loss, impotence, loose stools, irritable bowels, sensitivity to sunlight, sudden death, and long lines at the post office...)Brad
