One of the reasons for the record $2.04 billion jackpot for the Powerball drawing, which was announced Tuesday morning, is something you wouldn’t expect — the recent run of steep interest rate hikes from the Federal Reserve.
That’s because the size of the advertised $2.04 billion top prize is the amount winners would get, which involves taking 30 equal payments spread out over the next 29 years. Those payments come from an annuity purchased by the lottery sponsors, and the payments factor in an average rate of return. On Tuesday, Powerball adjusted the total jackpot from $1.9 billion to $2.04 billion.
But the thing is, the real prize is far more likely to be a much smaller lump sum, the “cash value” – which was $929.1 million prior to Powerball’s update – that never gets any attention.
“All anyone ever talks about is the annuity prize,” said Victor Matheson, professor of economics and accounting at the College of the Holy Cross in Massachusetts. “It’s the number the lotteries market. It’s the number in the news story. But it’s the number that almost no one ever takes.”
No Powerball winner since 2014 has chosen the “larger” annuity amount over the cash prize.
The cash value is the amount the prize would actually cost the lottery, either in a lump-sum payment now, or to buy an annuity to make those 29 subsequent payments. The current environment of rising interest rates has opened the door to ever-larger annuity payments.
In the low interest rate environment of recent years, the advertised annuity price was only about 50% or 60% bigger than the cash value, or sometimes less.
The largest Powerball jackpot ever won was in January 2016 when three winners split a prize advertised at $1.586 billion. Each took their share of the cash value, which added up to $983.5 million.
That advertised then-record annuity prize was 61% greater than the cash prize. Prior to the revised jackpot, the estimated annuity prize was 104% greater than the cash prize. If it was the same ratio as in 2016, that annuity prize would be only $1.5 billion.
And if interest rates were as low as they were in January of this year, that annuity rate would be only $130 million.
The current prize assumes a return on the cash value of about 5.75% a year, Matheson said.
But even a conservative investor in stocks could likely do better by taking the money up front and investing it, not withstanding the swings in the stock market. The Standard & Poor’s 500 has risen 728% in the 29 years since October 1993, or a compounded annual average growth rate of about 7.5%.
The larger assumed return associated with Monday’s jackpot’s annuity prize might make it more attractive to the next big winner or winners, said Matheson.
Then again, a disinclination to accept deferred gratification could overcome any investment assumptions or tax planning that goes into the winner’s calculations.