We’ve seen recently some huge jackpots surpassing $1 billion for Mega Millions and Powerball. But as some people know, those listed jackpots represent the annuity option. In other words, it’s the amount a winner gets paid only if they decide to receive 30 annual payments.
Meanwhile, a winner who chooses the cash/lump sum option only gets a fraction of the listed jackpot. As a result, a New York Times article calls lottery advertising “misleading,” and that’s because it is.
The author uses a good analogy, saying the prize amounts are like “bragging that you’ve got a $1 million job, when, actually, you’re paid $1,000 a week and expect to keep working for the next 20 years.”
To see how these jackpots are derived, let’s look at a $1.23 billion jackpot using the formula for the future value of a growing annuity. The listed cash prize (present value) is $595.1 million, the interest rate is 5%, the number of payments (years) is 30 and the annual payments are $32.35 million, leading to a future value of $1.23 billion.
If you were marketing the lottery, doesn’t it make sense to dangle a larger future amount instead of a smaller present amount? The New York Times article explains that state agencies, which run the lottery, are exempt from truth-in-advertising laws, hence the reason they can legally say “$1.23 billion jackpot” rather than “$595.1 million jackpot.”