The Powerball jackpot continues to climb and has now reached nearly $2 billion, making it the largest lottery prize in the world. There were no winners for last Saturday’s draw, continuing what is now a three-month jackpot streak that continues to grow.
The next draw is tonight, offering another chance for a $1.9 billion windfall. With so much money at stake, here’s a look at the most common mistakes people make when they suddenly acquire a fortune.
1. Choose a lump sum payment instead of an annuity
Jackpot winners have two options as to how they wish to receive their payment. The options include annual installment payments every year for 30 years, which in this case would be $63 million, totaling a jackpot of $1.9 billion.
Alternatively, winners can choose to receive a lump sum payment – an amount that is far less than the billions now at stake. Those who choose an immediate cash payment will receive $929 million.
But taking that lump sum might be the wrong move, says Robert Pagliarini of Pacifica Wealth, a certified financial planner and investment manager who specializes in working with lottery and Powerball winners.
“People almost always choose the lump sum over the annuity, which is the biggest mistake,” says Pagliarini. “I get it, I get why. People want the money now. The problem with that is then people can do whatever they want with the money. For some people it’s perfectly fine—getting a lump sum—unless you do some mistakes. And what we know about lottery winners is that they don’t make the best financial decisions.”
The advantage of taking the annuity is that even when the winners make some financial mistakes with their windfall, there’s still another $63 million coming in the next year, Pagliarini says.
“You can give it away, spend it very freely, invest it very little, and then repeat it because you get that payment every year for the next 29 years,” Pagliarini says.
There are other advantages to receiving the annuity payment – chief among them the late tax charge. Upon receipt of the lump sum payment, winners are required to pay upfront taxes on all such monies. That’s a federal tax rate of 37%, and depending on where you live, there will be state taxes to pay as well. On $1.9 billion in profits, federal taxes alone would amount to $700 million.
However, when you choose annuity payments, you only pay taxes on the $63 million in annual distributions, which significantly reduces your tax burden, to about $23,310,000 per year. And your final tax payment is not due for 30 years.
Annuity payments can also allow winners to adjust their wealth more gradually. “Getting the lump sum can give the winner control, but sometimes it can overwhelm the winner,” says Michael Liersch, head of advice and planning for Wells Fargo. “Taking the annuity can help spread the gains over a longer period of time, helping the winner adjust to new wealth.”
2. Overestimating your newfound wealth
Clearly $1.9 billion—a monetary value of $929.1 million—is a lot of money. But even when you’re talking such big numbers, winners end up thinking they have more money to spend than they actually do.
“Even if the lottery jackpot is $1.9 billion, the winners don’t actually have $1.9 billion,” Pagliarini explains. “If you made the mistake of taking the lump sum, that cuts your earnings in half to about $800 million. After paying taxes, you probably have about $400 million. So all of a sudden, you’ve gone from about $1.9 billion to $400 million.”
And none of that math accounts for the possibility that you won’t be the only big jackpot winner. When there are multiple winners, the jackpot is shared equally among all.
“If there are two winners, the prize is split 50-50 and so on,” explains Pagliarini. All of this means that the amount of money you end up with is likely to be less than you actually think.
The key point here is that it is important to hold off on spending until you understand the exact amount of earnings you will actually receive and the tax charges associated with that money. It’s a good idea to contact a tax professional right away to help you sort through these questions and help you plan appropriately.
3. Treating winnings like Monopoly money
When you win millions of dollars, the money may not even seem real, so you feel more comfortable spending it freely, without much thought. Some financial advisors describe it as seeing the money as Monopoly money, a reference to the popular board game.
Additionally, there are a variety of emotions wrapped up in money and how we handle our spending choices. Allowing emotions to drive your spending and decision making as a lottery winner can be a downward spiral, possibly even leading to bankruptcy.
“The Monopoly mentality for money knows no borders. It is difficult for many to control their material desires. Having a red Ferrari is great, but it would be nice to have a blue one as well,” says Philip Richter, co-chairman, president and partner of Hollow Brook Wealth Management, a firm that provides wealth management, including investment management and taxation and estate planning. “The consumerist nature of modern American society can lead many of us to want more and more even if our lives are already abundant. If one didn’t grow up in a world of privilege, it’s tempting not just to keep up with the Joneses, but to beat them by a wide margin.”
Pagliarini agrees, noting that because it’s such a huge amount of money, it just doesn’t seem tangible to people.
“Because you didn’t earn it and you know you didn’t earn it, you’re going to deal with it differently. It won’t carry the same weight as if you did. You’re going to spend it more freely, give it away more freely, and make riskier investments,” Pagliarini says.
The best way for lottery winners to avoid this Monopoly-money trap is to partner with a trusted investment professional who, as your fiduciary, will look out for your best interests at all times. “This trusted advisor will say no to frivolous spending and put together a rigorous, quantitative and ongoing financial plan that takes into account income, expenses, risk and asset allocation,” adds Richter.
A financial plan developed by a professional will outline what can reasonably be spent on a monthly, quarterly and yearly basis. Which brings us to the next mistake:
4. Failure to consult financial professionals
Handling the level of cash associated with a Powerball jackpot is a once-in-a-lifetime experience for the average person. But for some people, like wealth managers, CPAs, financial advisors and the like, managing huge sums of money is what they do every day.
If you happen to be among the lucky ones, be sure to immediately surround yourself with a team of experienced experts who can help you successfully manage your financial future, including advice on the wisest investments to make and how to budget the money.
“That team should include a lawyer, a tax person and a finance person,” says Pagliarini. “You want to work with people who have experienced this dozens — if not hundreds — of times. And you want to rely on them.”
5. Fall victim to lifestyle creep
With millions—or sometimes even billions—of dollars suddenly in your hands, it’s natural to be tempted to make big purchases like a car or home that you previously couldn’t afford. These types of purchases are examples of lifestyle creep, when an increase in income leads to excessive discretionary spending. But all these new possessions can also be expensive to maintain and add to your cost of living.
“Unbridled access to hundreds of millions of dollars provides limitless opportunities…planes, helicopters, racehorses and multiple homes are suddenly not only possible, but a tangible reality,” says Richter. “These types of luxury assets require a huge amount of maintenance and create significant ongoing costs.”
In other words, building empires consisting of multiple houses, cars, and other large purchases can lead to expenses that ultimately exceed your financial means—even as a lottery winner.
“People are really trying to change their lives too much. They feel like they have to turn everything around just because they have all this money,” Pagliarini says. “But you don’t have to do that.”
Instead, figure out what has worked well for you in the past, what you enjoy, and what you enjoy. And focus on those things. “Try to use money to improve your life rather than upend it,” says Pagliarini.
This story was originally featured on Fortune.com
More from Fortune:
The American middle class is at the end of an era
Elon Musk faces lawsuit again over $56 billion Tesla salary that’s ‘biggest in human history’
Winners of the $1.5 billion Powerball jackpot will likely get it in cash. This is a huge mistake, experts say
The US may be headed for a ‘triplidemia’—a doctor issues an urgent warning