Canadian teenager Charlie Lagarde had an enviable decision to make – how best to cash in her lottery win.
Miss Lagarde struck the jackpot after buying a scratch lottery ticket for the first time to mark her 18th birthday.
She had the choice between taking a C$1m (US$780,000; £550,000) lump sum or receiving C$1,000 a week for life.
She chose the tax-free weekly payment. BBC News asked two financial advisers to analyse her decision. Here is why they think she took the best option.
The fact that she is so young means that she has “overwhelmingly” made the correct decision, according to the experts.
From a purely mathematical perspective, it would take just over 19 years to reach a million by taking $1,000 a week. Living into her 80s would mean collecting more than $3m in total over her lifetime.
“This removes all temptation to spend on things that feel like more of a priority at the age of 18 than they might later in life,” said Sarah Coles, of UK investment company Hargreaves Lansdown.
However, individual circumstances should not be forgotten.
“If Charlie had racked up debts of $100,000 she might have chosen to take the lump sum and rid herself of the huge associated interest costs. This might be the same if she was paying off a mortgage,” said Tom Selby, senior analyst at pensions firm AJ Bell.
“Assuming this isn’t the case, it appears Charlie has made a very sensible decision.”
Still, the decision is a little more complicated than simple maths. This is why.
How about investing the million?
Some people might consider taking the million dollars and investing it to get a better return. That still would not be a better option financially for the teenager than taking the weekly payment, according to Mr Selby.
Here are his calculations, assuming an investment return of 5% (which represents a realistic, but not guaranteed return):
- If she spends nothing and invests the weekly payments ($52,000 a year), compared to taking the $1m lump sum and investing it, she would be better off by the age of 68. By the age of 82, she would have $24.9m compared to $23.8m
- If she chose the $1m lump sum and withdrew $52,000 a year, she would run out of money at the age of 83. Given Canadian life expectancy is 82, according to the World Bank, the withdrawals would last for her lifetime. However, it is important to note that the $52,000 would be taxable versus the tax-free weekly prize, which is the crucial point
- If she spends half of the $52,000 each year and invests the rest she would reach the $1m level by the age of 39 and by the age of 82 would have a lump sum of $12.5m
- Alternatively, if she had invested the $1m lump sum and taken the same withdrawal each year of $26,000 she would be worse off by age 75 and her fund value at age 82 would be marginally lower at $12m. In addition, the $26,000 would be taxed as income whereas the weekly prize is not
All this means that, for someone aged in their early 30s or older, the choice would be much tougher than it was for Miss Lagarde.
Cost of living effect
Miss Lagarde is young, and over time the value of her prize will be eaten away by inflation – the effect of the rising cost of living.
So would she be better off simply taking the million and spending it now, before it starts to fall in value in real terms?
No, according to Ms Coles, analyst at Hargreaves Lansdown.
It is impossible to know the future rate of inflation. However, a realistic estimate of a 3% inflation rate would mean that in 50 years, the $1,000 a week could be worth less than $250 a week in real terms in 50 years.
“It would therefore take her until the age of 47 to hit $1m in real terms, but even after taking inflation into account, her lifetime income from the win could be over $1.5m,” she said.
A choice for everyone?
All this sounds like a different world for most people. After all, hardly anyone wins the lottery.
Yet, there are some similar choices to make for many people who have saved hard during their working lives when they reach retirement. Many will be offered a lump sum, or a regular income for life, known as an annuity.
Ms Coles gives an example for someone in the UK heading into retirement.
“A woman retiring at the age of 65 with a pension pot of £1m, for example, might be offered a level income of £53,000 a year for life. This sounds far less exciting than £1m, but means she would break even at the age of 84 – with two more years of average life expectancy in the bag,” she said.
Mr Selby urges people to take their time over making such significant financial decisions.
“Deciding whether to take a small, regular income or a large lump sum can be extremely difficult. As human beings, we have a tendency to prefer receiving an ultimately smaller amount sooner than a larger total amount later. In the jargon, this is known as hyperbolic discounting,” he explained.
“If you’re lucky enough to be in a position like Charlie, the key is to think about all the factors that affect the value of your money and don’t make any rash decisions.”