Which is better: cash or payments?

Cash option

Cash amount you could receive now

Payment option

Payment amount

Years payments would last

General information

Years you'd like the money to last

Rate of return you can earn on your savings

Inflation rate

Your federal & state tax rate

"Which is better: cash or payments?" compares two payment options: receiving a lump sum today and living off the proceeds after paying income taxes; or receiving an annuity for a specific number of years and paying taxes each year. Lotteries are often paid as annuities.

The calculator discounts the annuity to a present value so that you can compare which option is the better deal. Generally, the option with a higher present value is the better deal. The savings interest rate that you designate is used to calculate present value for the annuity payment option.

For example, assume you won $1 million in the lottery. If your combined tax rate is 30%, your after-tax lump sum is $700,000. What if the lottery offered an alternative of receiving $50,000 a year for 20 years? The calculator shows that the present value for the cash option is a better deal, using a combined income tax rate of 30%, inflation rate of 3%, and savings interest rate of 5%.

You can annuitize the lump sum so that it lasts for the number of years you desire. For example, if you wanted to make the $700,000 last for 30 years, you would invest all but the first year's payment at the expected savings interest rate. The interest rate determines how much you can withdraw from the lottery fund for each of the years you want the money to last.

Net present value (NPV):Net present value is a method of determining the value of an investment in today's dollars. To calculate net present value, you discount future cash flows at the appropriate interest rate. You subtract your cash outlay from the sum of the present value of your cash inflows to determine your net present value. As a general rule, if net present value is positive, the investment should be made.

Lump-sum investments:A lump-sum investment is an investment that you make to open an investment or savings account. It is used to jump-start an investment or savings account. Possible sources of lump-sum investments include inheritances, lump-sum distributions from retirement plans and proceeds from a life insurance policy.

Present value:Present value is the value of a future payment, or series of payments, discounted at the appropriate interest rate to determine the value in today's dollars. For example, if you were given the choice of $100 today or a year from now, you would choose to take it now. You can invest or spend it. If you could invest it at 10%, you would have $110 a year from today ($110/$100). In other words, the present value of $110 a year from today is $100 if the discount rate is 10%. The discount rate should be at least equal to the inflation rate, which has averaged about 3% a year over the last decade. As a result, $103 a year from now has a present value of $100 ($103/1.03).

Inflation:Inflation is a general increase in prices that you pay for goods and services, stated as a yearly rate. If the inflation rate is 4%, it means that prices increase at a yearly rate of 4%. For example, the same basket of goods and services that you can buy today at $1,000 will cost you $1,040 next year. Inflation cuts into your purchasing power even further for longer periods. For example, if you have $100,000 today and inflation grows at 4%, it would be worth $82,193 in five years. After 10 years, it would be worth $67,556. The major inflation indexes are updated monthly by the U.S. Department of Labor. The first index is the wholesale price index. It is also called the producer price index (PPI). PPI measures inflation that manufacturers and other producers face. The second index is the consumer price index (CPI). CPI measures inflation that consumers face for goods and services such as food, fuel, and housing. Monthly PPI and CPI figures are reported as a percentage change over the previous month. A series of 12 monthly reports are linked to determine a yearly inflation rate.

Savings interest rate:The savings interest rate is the yearly interest rate you earn on your savings. It is also used to calculate the opportunity cost of paying with cash. In contrast, the saving rate is the percentage of income you save.

Annuitization:Variable annuities: Annuitization is the conversion of a purchase payment into an annuity, or series of payments, over a designated payout period. The payout period may be for a certain number of years or it may be for the remainder of the lifetime of the annuitant. Retirement and college planning: Annuitization is the conversion of a lump-sum investment into an annuity over the expected duration of retirement or college.

Annuity:An annuity is a series of payments. For example, a monthly payment of $1,000 for the next 120 months is a 10-year monthly annuity. Annuities are frequently used in retirement planning because of tax advantages that they offer. Insurance companies sell annuity contracts. A fixed annuity pays a constant amount. A variable annuity pays a variable amount that fluctuates with the investment performance of the underlying investments. Those underlying investments are called subaccounts or portfolios.

Discount:Discount is a price that is less than the regular sale price. In bond investing, a discount is a bond price that is less than the par value of the bond. Such a bond is said to be trading at a discount to par value. For example, a bond with a par value of $1,000 that sells at $985 is selling at a discount of $15 to its par value. A bond with a coupon rate that is below the market interest rate for similar bonds trades at a discount.