Lottery Winnings are Paid Like Annuities
Whenever you see a Powerball or state lottery jackpot advertised, they always mention some large number that is significantly larger than the amount you would get if you won and took one big lump sum payment. Lottery winners win an annuity of government payments that might be spread out over 20-30 years or more. By taking advantage of the time value of money, spreading the payments out over a long period of time should cost the government less due to inflation. If you take an inflation calculator and look at the inflation rates of the past 30 years and projected the same rates into the future, then a $100,000 payment in 30 years would have the same buying power as about $44,000 in today’s dollars.
Many lottery winners take the lump sum payment. They are OK taking less money than receiving more money over time. They (or those people giving them financial advice) might feel they can invest the money and earn better returns, they might feel inflation is going to be larger than expected, they might feel their are risks associated with the government stiffing them for part of the money, they might see tax rates skyrocketing in the future, or they might just want a bigger lump of cash right away. I suspect the majority of people don’t really consider the annuity option and just want the cash.
Investors Buy Income Streams
There are a lot of companies and investment funds that buy income streams like annuities, settlements, and lottery winnings. Some might offer a larger lump sum right up front when the person is still deciding whether to take the cash payout or the promise of future payments from the government. If the cash option is a raw deal and penalizes the lottery winner at a far greater rate than the expectation of inflation, it is possible that a hedge fund might be able to offer the lottery winner a larger check than the government would offer. Most of the time, however, the person has already chosen the income stream and something down the road causes them to change their mind.
The lottery winner might be under financial distress. Lottery winners sometimes thing that their luck in playing the lottery will translate into business success and end up investing in a business that fails. Others spend way to much money buying houses, boats, luxury cars, and other bling. Many are constantly shaken down by family members and friends for money. One guy even had the brilliant idea to fund a crystal meth ring. Besides financial distress, other reasons might be wanting a larger amount of money than their coming lump sums to make a large purchase, or realizing that due to some new diagnosis, they were unlikely to outlive the income stream. Sometimes the lottery winner sells all of their remaining payments and other times they sell off a portion of them in exchange for a lump sum.
Bankruptcy Court is Probably the Best Source for Deals
The one place that lottery winnings most frequently come up “for sale” is bankruptcy court. A recent Chapter 7 bankruptcy case (.pdf), presented an opportunity to bid on someone’s lottery winnings. The Debtor had won the “Set for Life Instant Game” about 7 years prior to filing for bankruptcy. The prize he had won promised to pay him $100,000 per year for a minimum of 20 years. Starting in year 21, it would only pay if the winner (the debtor) was still alive. The bankruptcy court in this case decided to offer the contingent portion (year 21 on) up for bid. It is possible that the person buying this interest will end up getting nothing (in the event that the debtor died in the next 12-13 years). Someone buying that income stream would be taking on an enormous amount of risk. Obviously buying the guaranteed portion would be much, much less risky. In that case, your main risk is just the State government defaulting and refusing to pay its debts; many investors would consider that unlikely to happen.