Why is the Powerball prize a record? Thanks to Fed Chairman Jerome Powell

Why is the Powerball prize a record? Thanks to Fed Chairman Jerome Powell

New York
CNN Business

One of the reasons for a record $1.9 billion jackpot because Monday night’s Powerball drawing is something you wouldn’t expect — a recent steep interest rate increases from the Federal Reserve.

That’s because the advertised $1.9 billion grand prize size is the amount the winners would receive, which includes 30 equal payouts of about $63 million spread over the next 29 years. Those payouts come from annuities purchased by lottery sponsors, and the payouts are a factor in the average rate of return

But the thing is, the real prize is more likely to be a much smaller lump sum, a “cash value”—in this case $929.1 million—that never gets noticed.

“All anyone talks about is the rent premium,” said Victor Matheson, a professor of economics and accounting at the College of the Holy Cross in Massachusetts. “It’s a lottery market number. It’s a number in the news. But it’s a number that almost no one ever takes.”

No Powerball winner since 2014 has chosen a “larger” annuity amount over the prize money.

The cash value is the amount the prize would actually cost the lottery, either in a lump sum payment now, or to buy an annuity to make those 29 subsequent payments. The current environment of rising interest rates has opened the door to ever-increasing annuity payouts.

In the low interest rate environment of recent years, the advertised price of an annuity was only about 50% or 60% higher than the cash value, and sometimes less.

The largest Powerball jackpot ever won was in January 2016 when three winners shared a prize advertised at $1.586 billion. Each took their share of the prize money, totaling $983.5 million, $54.4 million more than the prize money in Monday’s “record” drawing.

That advertised then-record annuity award was 61% higher than the cash award. This time, the estimated annuity award is 104% greater than the cash award. If it were the same ratio as in 2016, Monday’s annuity award would be just $1.5 billion.

And with interest rates as low as they were in January of this year, the annuity rate on Monday would only be $130 million.

The current award assumes a return on cash value of about 5.75% per annum, Matheson said.

But even a conservative stock investor could probably do better by taking the money upfront and investing it, not weathering the swings in the stock market. The Standard & Poor’s 500 has risen 728% in the 29 years since October 1993, representing a compound annual average growth rate of about 7.5%.
The higher assumed yield associated with Monday’s annuity award could make it more attractive to the next big winner or winners, Matheson said.

On the other hand, the reluctance to accept deferred gratification could overwhelm any investment assumptions or tax planning that go into the winner’s calculations.

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