Big lottery winners not on Easy Street

Monday, March 13, 2006 posted 10:06 AM EST

You’ve won $15 million in the Powerball Lottery?

Congratulations! But be careful: Making that kind of money last is not as easy as many people think. You may have to scale back your dreams of mansions, yachts and private jets.

The eight meatpackers who recently shared the record $365 million jackpot got their first reality check right away. By taking the money in a lump sum instead of a series of payments, they slashed their $45 million shares to about $22 million. After taxes, each has about $15 million.

Now they face the common rich person’s worry: how to keep taxes, inflation and overspending from chewing away what’s left.

The simplest strategy — the one that makes sense at the start — is to put the money into an interest-bearing investment, such as bank certificates of deposit or U.S. Treasury bonds. But “living on the interest” isn’t perfect.

Imagine you’re a winner, that you’re 45 years old and want your windfall to support you until you are 100. With Treasuries or CDs, you’re likely to earn an average 5 percent a year.

Your $15 million will earn $750,000 a year. But interest is taxed at income-tax rates — and you’ll be in the top tax bracket, paying 35 percent, thus cutting your income to $487,500.

With 55 years to finance, you’d have to put at least $200,000 of that back into the account every year to slow the inflation damage, assuming inflation averages about 3 percent a year.

So you’d be left with about $290,000 to live on over the next 12 months. To keep up with inflation, each year you could increase that by 3 percent. When you turn 70 in 25 years, you’d withdraw about $600,000. But that would only buy what $290,000 buys today. When you’re 99, you will withdraw about $1.4 million to get that buying power.

Then the account will be empty.

Of course, we’re just setting a baseline here. This is the simplest way to get income right away, without taking any risk or hiring a team of professionals for advice.

But you can be sure that as news of your good fortune spreads, people will be crawling out of the woodwork with investment opportunities — hedge funds, tax shelters, chances to buy into shopping centers and start-up businesses. ...

Say no to any unsolicited offer. There’s plenty of time to search for a really good, affordable adviser and to gradually tweak your investment strategy to produce more income.

Don’t, under any circumstances, give anyone authority to buy and sell in your accounts without your OK on every transaction.

Eventually, you may want to consider sophisticated strategies such as setting up trusts to provide for heirs. But first I’d look to a few basics, like how to reduce taxes on the income you’re earning now.

You could cut your taxes to nothing, for example, by investing in municipal bonds sold by local, county and state governments. Rich people love munis.

Right now, for example, some mutual funds specializing in top-quality Pennsylvania munis yield about 4.6 percent. At this rate, your $15 million would earn $690,000 tax-free. Even after reinvesting a couple of hundred thousand as an inflation hedge, you’d have $200,000 more a year than if you’d bought Treasuries.

Another option is to invest in stocks or stock funds that pay dividends, which are taxed at no more than 15 percent.

Or invest in growth stocks and hold them for more than 12 months, so your profits will be taxed at the long-term capital gains rate of 15 percent. Over long periods, stock returns average around 10 percent a year, though it would be foolish to count on that much — or to put all your money into stocks, which can go into long slumps.

With help from an accountant or other financial adviser, you’ll probably end up with a mix of holdings to spread your risk around.

Just keep one thing in mind: Even with $15 million, you are not necessarily set for life — lots of rich people lose their money.

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