One of the reasons for the $1.6 trillion jackpot for Saturday night’s Powerball drawing is something you might not expect: the Federal Reserve’s recent spate of steep interest rate hikes.
Therefore, the announced $1.6 billion grand prize size is the amount that the winners would receive, which involves taking 30 equal payments of about $53 million spread over the next 29 years. These payments come from income purchased by lottery sponsors, and payments are based on an average rate of return.
But the point is, the real prize is much more likely to be a smaller amount, a “cash value” — in this case $782.4 million — that never gets attention.
“All anyone talks about is the annuity premium,” said Victor Matheson, a professor of economics and accounting at the College of the Holy Cross in Massachusetts. “It’s the lottery market number. It is the number of the news. But it’s a number that almost no one takes.”
Not since 2014 has a Powerball winner chosen a “higher” income amount over the prize money.
The cash value is the amount the prize would actually cost the lottery, either in one payment to date or to purchase an annuity for those 29 future payments. The current environment of rising interest rates has opened the door to higher income payments.
In the low interest rate environment of recent years, the announced annuity price was about 50% to 60% higher, or sometimes lower, than the cash value.
The current annual prize is surpassing the record set in January 2016, when the three winners shared an advertised prize of $1.586 billion. Each took their share of the cash value, which added up to $983.5 million, $200 million more than the prize money in Saturday’s “record” drawing.
The advertised record annual award was 61% higher than the cash award. This time, the annual prize is 104% higher than the cash prize. If the ratio were the same as in 2016, Saturday’s annual prize would be only $1.26 billion.
The current award represents a return on cash value of about 5.75% per year, Matheson said.
But even a conservative stock investor could do better by taking the money up front and investing it without being exposed to the swings in the stock market. The Standard & Poor’s 500 has risen 728% in the 29 years since October 1993, or an average compound annual growth rate of about 7.5%.
The presumed higher returns associated with Saturday’s annual prize could make it more attractive to the next big winner or winners, Matheson said.
Again, reluctance to accept deferred gratuity may override the investment assumptions or tax planning that go into the winner’s calculations.