The Eclectic Economist

The Eclectic Economist

Odds are $1.5 billion Powerball winner will end up bankrupt

The Powerball prize got so big that it wouldn’t fit on some signs – and it keeps growing. Reuters

The U.S. Powerball lottery is holding a drawing this week for a jackpot that’s already reached US$1.5 billion. That’s after the 18 drawings held since November failed to yield a winner, causing the grand prize to swell to this record sum.

This jackpot is drawing such attention that more people are buying tickets, and even the lottery’s own projections are changing rapidly. During the weekend the payout was an estimated $1.3 billion. Monday it was revised to $1.4 billion and on Tuesday it hit $1.5 billion.

That makes it the largest lottery grand prize the world has ever seen, even compared with the “El Gordo” lottery in Spain, which in December awarded a larger cache of prizes ($2.4 billion) but spread it among thousands of winners.

The odds of winning this huge sum of money on January 13 are very small (1 in 292 million). You are 250 times more likely to be hit by lightning. If every adult in the U.S. purchased just one ticket, each with a different number, there would still be a good chance (about 15 percent) that no winner would arise and the pot would grow even larger.

On Wednesday night, however, a winner is actually very likely, since many lottery players are not limiting themselves to a single ticket and the massive prize is luring hordes of Americans to try their luck, along with – reportedly – thousands of Canadians.

Once a winner is declared a more interesting question arises: what happens to all that money and the lucky ticket holder(s)?

Fortunately for us, academia has a lot to say about it.

A smaller prize than it seems

Most of the academic research has dealt with smaller lottery prizes and inheritances, since there are relatively few giant jackpot winners. But while the $1.5 billion jackpot is eye-wateringly large, the actual payout will be much less.

Wednesday night’s winner or winners will not actually receive $1.5 billion. Assuming just one person wins it, he or she can either choose a lump sum payment that amounts to about $930 million or will have to wait 30 years for all the payments to accrue.

And then there’s the taxman’s big bite. Forbes estimates that a single winner in a low-tax state, like Florida, who elects to take all the money in one lump sum instead of in 30 payments will get a check for about a half-billion dollars.

That jackpot is starting to look a lot smaller, though it’s still a fair chunk of change.

What happens to windfalls

Previous research suggests many people quickly spend any unexpected windfalls. A 2001 paper (by economists Guido Imbens and Bruce Sacerdote and statistician Donald Rubin) found that lottery winners saved just 16 cents of every dollar won.

Other studies found that instead of getting people out of financial trouble, winning the lottery got people into more trouble, since bankruptcy rates soared for lottery winners three to five years after winning.

It is not only winning the lottery that causes people to spend. My own research found that the average person in their 20’s, 30’s and 40’s who was given an inheritance or large financial gift quickly lost half the money through spending or poor investments.

Overall, research shows lottery winners and people getting windfalls spend or blow through much of the money. Nevertheless, lottery sales in the U.S. have increased dramatically since their introduction in the 1970s.

Blowing it all

So how exactly does a lottery winner blow through hundreds of millions of dollars?

Demographic research on lottery players’ characteristics shows that lottery playing peaks when people are in the 30-39 age range and actually falls as people get older.

The average person in the U.S. lives to age 79. This means a sole winner “blowing through it all” (and ending up with no assets to show for it) would have only about 45 years to spend the entire after-tax half-billion dollars (assuming a lump sum payment). That means the person would have to spend more than $10 million a year, roughly $30,000 per day (ignoring any interest accrued).

It is important to understand that most of the academic research separates out spending from investing. If a lottery winner “blows” all his money on expensive homes, paintings and very high-end cars, his net worth does not actually change.

Instead, he has simply transferred one asset, which is cash, into another asset, like real estate, artwork or exotic cars. At the end of his life, if real estate, art and auto prices have not fallen, he is still just as rich as when he won the lottery.

Blowing through the money, which leads to bankruptcy and low savings rates, means the winner has nothing to show for their spending besides a good time.

Could that happen with the latest jackpot?

We’ve already established that a sole winner of this week’s lottery will probably end up with a lot less than $1.5 billion. But imagine for a second that a lucky person manages to win all of that money; would it be possible to spend it all and arrive at life’s end with nothing to show for it?

In fact, it has already been done once by a man named Huntington Hartford, who lived from 1911 to 2008.

Huntington was the heir to The Great Atlantic & Pacific Tea Company fortune. This company, which started just before the Civil War, is better known as the A&P supermarket chain. A&P was the first U.S. coast-to-coast food store, and from World War I to the 1960s was what Walmart is for today’s American shoppers.

Huntington inherited approximately $90 million when he was 12. Adjusting for inflation means he was given almost $1.3 billion as a child, after taxes. Huntington declared bankruptcy in New York in 1992, approximately 70 years after being handed one of the largest fortunes in the world.

Huntington had the reverse Midas touch. He lost millions buying real estate, creating an art museum and sponsoring theaters and shows. He combined poor business skills with an exceptionally lavish lifestyle. After declaring bankruptcy, he lived as a recluse with a daughter in the Bahamas at the end of his life.

Huntington’s life story – coupled with academic research that suggests people quickly spend their windfalls – means not only that you have very long odds of winning Wednesday’s $1.5 billion Powerball jackpot prize, but you have just as long odds of keeping money around after winning it.

If you are planning on playing, I wish you good luck. If you are planning on winning, I wish you even more luck.

Nevertheless, the key lesson for everyone, whether you play or not, is that when you get a windfall or win the lottery, plan ahead and resist the all-too-human temptation to spend all the money.