Since I have a good friend who plays the lottery all the time and he was asking me about what to do with his estate planning if he won the lottery jackpot, I thought I would offer some basic information here:
Before you claim the lottery jackpot: setting up your estate planning
There are several things to consider before you claim the lottery jackpot and cash in your ticket. Here are three:
1) Do you plan to share your lottery jackpot with someone else? This is a key issue if the jackpot is especially large. People who play the lottery all the time often think they will share with their brother, cousin or other relative if they win a large jackpot. This is a great gesture, but the relative should be added to the ticket as a co-owner of the ticket before it is claimed. Usually this is done by adding his name (along with yours) to the back of the ticket. That will indicate to the lottery commission that you both won and that checks should be issued to each of you (and likewise reported to the IRS). This keeps the winnings (and all tax reporting) easy and clean right from the start.
2) Do you want to remain somewhat private about winning the lottery jackpot? If you don’t want your name to be in the papers and on the lottery website as the outright winner, you should consider taking your winnings as trustee of a trust. You do this by having a trust prepared and signed prior to claiming the lottery jackpot, and signing the ticket as trustee of the trust, NOT with just your individual name. By trust I am referring to a revocable trust. In a revocable trust you could be the owner, the trustee and the beneficiary AND you could indicate who would receive the assets once you are gone. You could name the revocable trust anything you choose. In this example I’m using The Purple Mountain Trust. It would be set up under your social security number and, therefore, act as a pass-through for the assets placed in the trust. Once you had your trust prepared and signed, you would claim your lottery jackpot like this: Joe Blow, Trustee of the Purple Mountain Trust, OR like this: The Purple Mountain Trust, Joe Blow as Trustee. As far as the lottery commission is concerned, the trust owned the winning ticket and Joe is the trustee representing the trust. Since the trust would only be a conduit, additional planning could easily be done once the winnings were in the trust.
Another step in claiming the lottery jackpot as trustee of a trust, is to set up a trust account prior to claiming your ticket. This is simply a bank account or brokerage account that would have the same title as the trust: Joe Blow, Trustee of the Purple Mountain Trust OR The Purple Mountain Trust, Joe Blow as Trustee. In setting up an account like this, the bank will want to know that the trust is already in existence, meaning you would take your trust document to the bank when getting the account set up. Once this is in place, the account is ready to receive the lottery jackpot winnings.
3) Do you plan to give to charity? Some people want to know straight off how to give charitably after they win the lottery jackpot. If this is a consideration, you should know that giving charitably is tax friendly, meaning there are some tax advantages in doing this. You have the option of adding a charity as a beneficiary of your revocable trust when you set up the trust (and before you claim the lottery jackpot) or you can take several steps to achieve gifting after you claim the lottery jackpot. Or you could do both. Either way, you do not have to add a charity as a co-winner on the winning ticket in order to make a gift. Options regarding gifting after you claim your lottery jackpot will be discussed below.
After you claim your lottery jackpot: how to use your estate planning
How you have your estate planning set up may depend on the size of your lottery jackpot. If you have a modest jackpot, you may not need to do more than what was mentioned above. The minimum Texas Lotto amount is $4 million dollars. After claiming the lottery jackpot and receiving the net (after the lottery commission pays part of it to the U.S. Treasury), you should think long term. Each $1 million invested at 5% would generate $50,000 in income each year, and $3 million invested at 5% would generate $150,000 each year. Not bad, but in 20 years or so it may not be all that much. On the other hand, if your lottery jackpot is $100 million, you probably need to consider additional estate planning. Some of the considerations are as follows:
1) Taxes–the following tax rules affect advanced estate planning and should be considered for those with large winnings:
- Everyone has a lifetime tax exemption amount, meaning they can give away that amount during their lifetime or at death without paying federal estate tax. Currently that amount is over $5 million. For married couples, it is over $10 million.
- A person can give $14,000 each calendar year to anyone without counting as part of the lifetime exemption
- Charitable gifts do not really count in the lifetime exemption amount
- The estate tax is 40% for amounts in the estate over the exemption amount
- Some states (not Texas) have a state estate tax with an exemption amount less than the federal government
- Using irrevocable trusts as part of your overall plan. Lots of people utilize irrevocable trusts in planning. An irrevocable trust cannot be reversed, owns the assets placed in the trust and has its own tax I.D. and tax reporting every year. These types of trusts work for asset protection because the money placed in the trust is out of your name entirely, even if you continue to receive the income from the trust every year. Some irrevocable trusts can be charitable. Often called charitable remainder trusts, once the money as moved into your CRT, you could receive the income each year. On your death, your named charity would receive the principal.
- Moving your residence to a debtor friendly state, such as Texas or Florida. In these two states, there are lists of assets that are not reachable by creditors, such as your homestead and annuities. Supposedly, this is one reason why O.J. Simpson moved to Florida.
- Setting up an offshore trust. Supposedly offshore trusts do not have to respond to a judgment by a court in the U.S. so the idea is that even if you are sued and lose, the person suing you cannot get to your assets held offshore. That’s a great idea, but it doesn’t mean that you couldn’t be held in contempt of court for failing to comply with a court order (meaning you could be sent to jail for failing to comply).
- Setting up Family Limited Partnerships and/or LLCs. This has been a fairly established system of reducing the value of assets you hold and making it difficult for people to reach through the web of entities to get to the assets. It is possible that the IRS is taking a new look at these and how all this is reported. These are basically businesses that are set up properly to function with each other, and they create significant paperwork each year. A good CPA is a must if you go this route.