Hitting the Jackpot Changes Everything: Critical Estate, Financial, Tax and Charitable Planning for Lottery Winners

Winning the lottery changes a person’s financial life overnight. Before the prize is claimed, however, the winner needs to consider how that sudden wealth affects taxes, privacy, family arrangements, gifting, and the Estate Plan.

The first step before claiming the prize is to get professional advice. Enlisting the services of an Estate Planning attorney, CPA, and financial advisor can help the winner understand the claim process, payout options, tax consequences, and privacy rules. Lottery tickets have claim deadlines, so there is a limit to how long a winner can wait, but there is usually good reason to understand the available options before filing the claim.

Ownership of the ticket should also be clear. A ticket may have been purchased by one person with his or her own money, or it may have been bought for a family or group that regularly shares the cost. If more than one person has an ownership interest, that arrangement should be documented before the prize is claimed.

This can matter more than family harmony. If one person claims the entire prize and later gives portions to others, those transfers may be treated differently for tax purposes than if the other participants already owned their shares of the winning ticket. A written agreement can identify the participants, their respective percentages, and how the winnings will be divided.

Depending on the circumstances and state lottery rules, a Trust, LLC, partnership, or other structure may also be worth considering. If an entity will be used, the governing documents should reflect the actual agreement among the participants. They should also address what happens if one participant dies, becomes incapacitated, divorces, or is unable to participate before all proceeds are received.

The payout choice is another important decision that has Federal, and potentially state, income tax consequences. Most large prizes involve a choice between a lump-sum payment and an annuity. A lump sum gives the winner immediate control over the proceeds and may provide greater flexibility for investing, gifting, or other planning. It also means the winner must begin managing a substantial amount of wealth at once.

An annuity spreads the payments over a period of years and may provide more structure. It does not, however, eliminate the Estate Planning issues. The winner should understand what happens to unpaid installments at death, who can manage the payments during incapacity, and how the payment stream will be handled under the Estate Plan.

Taxes should be addressed before the winner starts spending or making gifts. Lottery winnings are taxable income, and the amount withheld from the prize may not equal the winner’s final tax liability. State taxes may apply as well, depending on where the ticket was purchased and where the winner lives.

That makes it important to determine how much should be set aside before the winner starts paying off mortgages, buying property, or making large gifts. The amount deposited into an account may look substantial, but it should not automatically be treated as entirely available for spending.

Family gift considerations deserve some planning as well. Many winners want to help parents, children, siblings, and perhaps close friends. Those gifts may include paying off a mortgage, buying a home, giving cash, or setting aside money for education.

Those gift decisions can have gift tax and Estate Planning consequences. A winner may also want to consider whether certain gifts should be made outright or in a Trust. For younger beneficiaries, or for family members who may need creditor or asset protection, an outright gift may not be the best choice.

Having a gifting plan can also help manage expectations. It is easier to decide in advance how much the winner is comfortable giving than to make separate decisions each time someone asks for help.

Privacy rules should be reviewed before the claim is filed. Some states allow lottery winners to remain anonymous, while others require disclosure of the winner’s identity. In some states, a Trust or other entity may be able to claim the prize, although that does not necessarily mean the individuals behind it will remain private.

Once a large win becomes public, the winner may start hearing from relatives, charities, investment promoters, strangers, and people with business ideas. Knowing in advance what information will be released allows the winner to prepare for that attention.

The winner’s existing Estate Plan will very likely need significant changes. A Will or Trust created for a modest estate is often no longer appropriate after receiving a large jackpot. Powers of attorney, health care documents, beneficiary designations, and any existing asset-protection planning should all be reviewed.

Fiduciary appointments are especially important. A family member who was a reasonable choice to serve as successor Trustee when the estate consisted of a home and a few investment accounts may not be the best person to manage a much larger portfolio. A professional fiduciary, corporate Trustee, or co-Trustee arrangement may be worth considering.

The Estate Plan should also address what happens if the winner becomes incapacitated. Sudden wealth creates management issues during life, not just at death. Someone may need authority to oversee investments, real estate, business interests, and other assets if the winner is unable to act.

Charitable planning often becomes part of the conversation as well. A large jackpot can give a winner the ability to support charitable causes on a scale that was not previously possible. Depending on the winner’s goals, this may involve direct gifts to charities, establishing and funding charitable trusts, a private foundation, or a donor-advised fund.

The timing and structure of charitable gifts often have significant impact on achieving desired results. Therefore, charitable planning should be coordinated with the rest of the tax and Estate Plan rather than handled separately.

A lottery win may happen in an instant, but the decisions that follow do not need to. Before claiming a major prize, making large gifts, or committing the proceeds elsewhere, the winner should understand what options are available and which decisions may be difficult to change later.

For anyone holding a significant winning ticket, or participating in a family or group lottery arrangement, getting legal, tax, financial and charitable advice before the claim is filed can preserve options and help prevent avoidable problems once the money arrives.

Jensen Puno
Staff Attorney
American Academy of Estate Planning Attorneys, Inc.
9444 Balboa Avenue, Suite 300
San Diego, California 92123
Phone: (858) 453-2128
www.aaepa.com