September 21, 2018
Before I begin, let me just say that the chances that someone wins any lottery prize are always going to be extremely low. The chances are actually higher that you get hit by lightning than they are for you winning the Powerball lottery.
Let’s say that despite the chances of winning being very miniscule, that you do win the lottery. Whether the prize is $100,000 or $50 million, winning the lottery will have a pretty big impact on anybody’s life. Unfortunately, it is a fact that many lottery winners go broke a few years after winning the lottery. The usual pattern that many winners have where they quit their job, go on year-round vacations, and buy new houses and cars hasn’t panned out well. The amount of money won is so foreign that the decision making with that kind of money is also foreign. This makes you wonder what the different mindsets are after winning the lottery. For some people, they may be fine with living it up and then going broke. They just want to live a fantasy lifestyle for a few years before returning to their old lifestyle. I think the majority, however, don’t plan for that. They didn’t build up to that level of wealth with a steady increase of cash flows growing larger and larger over the years where their spending would have gradually adapted. They don’t understand the limitations of money. Realistically, if you were to win a $3 million after tax lottery prize and you don’t have cash flows still coming in regularly, $3 million will not have as big of an impact on your lifestyle as you many people would think. If you were to plan accordingly, you could definitely live comfortably on $3 million for the rest of your life, but you could not live an extravagant celebrity lifestyle and have it be sustainable.
Let’s compare two scenarios: Both scenarios are of a 40 year old couple with an 8 year old child. Prior to winning the lottery, they are earning the median household income for the US, $57,617 (Guzman). They are currently living in a $250,000 house with a mortgage balance of $120,000. All of their liquid assets are invested in a 60/40 mix of stocks of bonds. In one scenario they win the lottery and in the other scenario they do not win the lottery. I’m going to go over what it takes to have a sustainable lifestyle in each scenario. It is factored in that all of their expenses increase with inflation.
Losing the Lottery
With no changes to their financial situation, the family remains at the same house for the rest of their lives. Both spouses continue working until age 65 when they retire. Their salary increases by 5% each year. They are able to spend $1,500/month every year on living expenses on top of their mortgage payment and any health care expenses. They are able to contribute the max contribution amount to Roth accounts for each spouse and they also contribute to their 401(k)’s up to their employer maximum match. They can maintain this $1,500/month budget through their retirement until death. Each spouse can purchase a new car every 12 years that has a value of $15,000. They can afford $5,000 for four years in assisting with their child’s college expenses. Following this plan they have a 73% probability of being able to maintain these spending goals until their deaths.
Looking at the graph, the median asset values are well within an acceptable range in the final year, but because they are both 40, they have 50 years where any number of variables could affect this plan. They still have a 73% probability, so for their situation they are looking good.
Winning the Lottery
When they win the lottery, they receive a $3 million lump sum after taxes and other fees. Both spouses retire when they receive their lottery winnings. They pay off their loan, sell their house and take out a mortgage on a $500,000 house. Each partner gets a new car every 10 years valued at $30,000. They are able to pay for four years of their child’s college education at a public university when the child is of age. On top of these expenses and their medical expenses they can spend $2,300/month and remain retired for the rest of their life. This plan gives them the same probability of success as their plan when they did not win the lottery.
Looking at the graph you can see that they have a chance of ending up with a lot more money than if they didn’t win the lottery with this plan, but there is also a chance that they run out of money by age 81. With both plans they have 50 years remaining in their life, but in the plan where they win the lottery they don’t have regular cash flows from their income and their social security benefit is going to be much less due to their early retirement. There is a lot more risk they have to deal with.
As you can see, if you win $3 million from the lottery it’s possible to quit your job and live a slightly more expensive lifestyle, but you’re not going to be living like a Rockstar anytime soon unless you want to end up like most lottery winners that go broke a couple years later. For many people being able to retire at such a young age is huge, but keep in mind they are limited by their child and their budget of $2,300/month. For some people, $2,300/month is more than enough, but for a couple that retires at age 40 with significantly more free time than they had before, they might find it harder to maintain that budget than you would expect. I only showed two opposing scenarios that are sustainable, but there are likely many other strategies for how someone could live successfully after winning the lottery.
Guzman, Gloria G. “Household Income: 2016 American Community Survey Briefs.” United States Census Bureau, US Department of Commerce, Sept. 2017, www.census.gov/content/dam/Census/library/publications/2017/acs/acsbr16-02.pdf.
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