This is a two-part series concerning planning for lottery winners. The first part concerns avoiding pitfalls. The second part concerns planning strategies to consider.
Now that the lottery winner has avoided some of the possible pitfalls, let’s look at some planning options. Many lottery winners fail to plan properly. As a result, many winners declare bankruptcy within a few years. Here’s a story on Time.com discussing this surprising fact.
First, of course, the lucky winner should pay off their existing debt. Next, a lottery winner could consider giving a portion of their winnings to charity. For ease of example, let’s say the winner won $100 million in a lump sum. It would be federally taxable as ordinary income at a top rate of 37%. Let’s assume the winner lives in California or one of the several states which doesn’t tax lottery winners. If the winner kept everything they could, they’d have around $63 million after tax. Let’s say they gave half of it to charity, they’d benefit the charity with $50 million and they’d still have $31.5 million. This is consistent with the “Giving Pledge” through which some of the wealthiest people pledge to contribute half of their wealth to charity. Click here to learn more about the Giving Pledge. But, this wouldn’t protect against the possibility of the winner squandering the remaining assets and ending up in bankruptcy like others with a windfall.
To keep themselves from squandering the winnings, they could give to their favorite charity and receive a charitable gift annuity in which they receive an income stream for their life. They could also give the assets to a Charitable Remainder Trust and receive an income stream for the remainder of their life. Depending upon the specific details, both these options would benefit charity and would reduce the income tax burden by providing a current income tax charitable deduction to the lottery winner.
To the extent they were not charitably inclined, they could contribute the money to an irrevocable trust for their own benefit with a third-party as trustee. This could protect the assets from their own mismanagement and in some states could even protect them from their own future creditors.
To the extent they want to leave more than the estate tax exclusion (currently $11.18 million but cut in half beginning 2026) to non-charitable beneficiaries (like their relatives), there are many planning techniques to maximize the use of exclusions. The simplest way is to give the “annual exclusion” of $15,000 each year to each person they want to benefit. Let’s say they have 20 people they’d like to benefit, that would be $300,000 each year they could give without counting against their estate tax exclusion. They wouldn’t even have to give outright for it to qualify for an annual exclusion—they could give to special trusts and qualify for the annual exclusion for each beneficiary who had a temporary withdrawal power, known as a “Crummey” power.
Whatever the lottery winner’s desires, congratulations on winning! An estate planning attorney can help protect the newfound wealth from the many obstacles out there, including income tax, estate tax, and even the temptation to blow it all.
Stephen C. Hartnett, J.D., LL.M.
Director of Education
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128