Although winning the lottery can be exciting, it carries enormous estate and gift tax implications. Finances can dwindle away in no time if they are not managed properly.
Lottery winners have the option of taking the prize as a lump sum or an annuity that is divided into 30 annual payments. California exempts lottery winnings from income tax. However, a chunk of winnings are withheld for federal taxes. The annuity payments are also subject to the same federal tax albeit spread over each installment.
Establishing a trust can help lottery winners maintain a degree of anonymity and provide a tool for managing assets and finances. Trusts can also allow the future transfer of wealth to children and other heirs with minimal estate tax exposure. If a prize is assigned to a qualifying revocable living trust, the lottery will make installment payments to the trust.
Lottery winnings present a number of estate planning challenges. If a person with special needs wins the lottery, the winnings are likely to affect eligibility for government benefits such as Medicaid.
If the prize is received in an annuity towards the end of a winner’s expected lifetime, they could die before receiving all the installments. The balance of future payments then become part of the estate, like other assets. In such cases, the estate’s representatives will begin the process of transferring payments to heirs. The process is simpler if the winner has designated beneficiaries.
One of the first things a lottery winner should do is consult a lawyer to prevent making major mistakes. The cost of not taking the necessary estate planning measures can be devastating.