The lottery is a strange game because you may have to spend a bunch of money to get a return on your investment. But the chance of a giant payout for a Mega Millions jackpot or Powerball jackpot is enough to make it one of the most popular pastimes in the country.
But when you give the lottery retailer your cash, where does that money go? After all, when the jackpots are as high as billions of dollars, it seems there can’t be any money left over.
Here’s the thing — the lottery system is a carefully curated sector of the national government that functions to fund more stuff than you might know. Here’s precisely how the lottery makes money and where that money goes.
What Are the Basics of the Lottery System?
The federal government operates the lottery system, though states have total control over which lottery games they want to participate in. While there are multi-state games like the Mega Millions and Powerball lotteries, individual states might also offer their version of scratch-off tickets.
You can buy a lottery ticket at a lottery retailer, a physical location that sells and redeems lottery prizes. More often than not, gas stations, convenience stores, and grocery stores are lottery retailers.
When playing a multi-state game, you’ll need to choose your set of winning numbers. You can tell the retailer your choice of numbers or choose a “quick pick” to have your numbers randomly selected. These numbers will then get drawn bi-weekly to see if you’re a winner.
Often, those drawings will not reveal a winner. If that’s the case, the funds get added to the grand prize total, and the next drawing’s jackpot will be even higher. So, what's the point in the lottery system if the money you hand the retailer just gets added to the pot? Does anyone make any money off of these things?
How Does the Lottery System Profit?
The odds of winning the lottery are one in 302,575,350. Putting that into perspective, the odds of being struck by lightning are much higher (though still less than one in a million). Still, lottery games are prevalent, and many people continue to play them. There are a few reasons why the lottery seems to continue to rake in the dough, even when you might get some losing tickets.
Taxes
Taxes are often the bane of people’s existence, but they’re a necessary evil to have a well-established foundation in your state or town. And like many goods or services, lottery winnings are taxed.
Taxes can differ by state, but in many cases, you can expect to dish out nearly 40% of your total winnings back to your state in taxes. That leaves you just $600 million after a $1 billion jackpot win. This is the primary way that the lottery system profits. That’s still a lot of money, but it’s something you’ll need to consider before you play.
The bigger the jackpot, the more money the state receives back in taxes. In a way, the lottery system relies on people not winning or claiming their ticket to allow that jackpot to grow higher because the higher the jackpot, the more money the state receives in taxes.
Two states, Delaware and California, do not tax lottery winnings. But every other state will subject you to the wrath of a percentage loss. The good news is that those funds help improve your state through funding the education system and gambling addiction recovery.
Independent Probability
One of the ways that the lottery can “fool” its players into spending more on tickets to drive up a big jackpot (and large tax payout) is through the idea of independent probability. While it might feel natural that if you play every day, you’re more likely to win, this is a fallacy that the lottery system is not forthcoming about.
All lottery drawings are independent, meaning each drawing exists as its singular entity. Yesterday’s drawing does not influence tomorrow’s, meaning that you cannot increase your odds simply by playing more often. Many people feel that if they play more often, they might be able to increase their odds.
The only way to increase your odds is by buying multiple lottery tickets for the drawing. But even then, the odds are still entirely small.
Media Publicity
News outlets and social media don’t do anything to stop the lottery from profiting. News stories surrounding huge jackpots are another reason the lottery system makes so much money. Frenzy and hype surrounding a huge multi-state lottery jackpot make people more inclined to give it a go.
After all, you might never forgive yourself if you decide not to play and your winning numbers get chosen. So when the media does stories about the lottery, it entices more people to give it a go (spending more money).
What Is Lottery Money Used For?
When the lottery takes back some money from taxes, where does all that money go? Especially since some of those taxes can amount to hundreds of millions of dollars, one would hope they’re going to good causes.
About 50-60% of the jackpot prize goes to the winner. But the rest of it is distributed into three major categories.
Overhead Costs: About 10% of Total Prize
The lottery system doesn’t just function on its own. Some people work behind the scenes to design scratch-off games, record the live drawing events, keep the websites up to date, and work at the lottery headquarters to help you after a big win.
This is the overhead cost to run the lottery system, and a portion of the winnings goes towards funding the workers and administrative costs associated.
Commissions to Lottery Retailers: About 5% of Total Prize
A small portion of the winnings will go to the retailer who distributed the winning ticket. While it’s not much, commissions are earned for selling tickets, even if they aren’t winners. For smaller prizes, retailers might make a bit extra. Generally, lottery sales earn about $15,000 to $20,000 yearly in bonuses and commissions.
However, retailers earn a larger ticket sales commission if that ticket is a winner. For instance, when an Illinois man won the $56 million Mega Millions ticket in 2021, the distributing store was able to shake out a $500,000 commission for the sale.
State Governments: 35-45% of Total Prize
Most of the money outside your winnings ends up going back to the participating states. States have complete control over how to use this money, though many use it to enhance the state’s infrastructure.
Common uses for lottery money include:
- Funding support centers and groups for gambling addiction or recovery.
- Enhancing the general fund to address budget shortfalls, roadwork, bridgework, police force, or other social services.
- Funding the public education system.
- College scholarship funding.
- Public works allocation.
Individual states have also gotten creative with their state lottery revenue. For instance, Minnesota puts about 25% of lottery revenue into the Environment and Natural Resources Trust Fund to ensure water quality and wildlife regulations. Meanwhile, the Pennsylvania Lottery has invested over a billion dollars into programs for the elderly, like free transportation and rent rebates.
So even if you don’t win the lottery, you can feel like you’re doing something good for the participating state either way.
Can You Prevent Getting Taxed on Lottery Winnings?
While smaller lottery prizes (under $600) can be redeemed at lottery retailers without taxation, larger jackpots will need to be taxed. Generally, any winnings over $1,500 require taxes.
There is no way for you to prevent this hit from removing some of your prize money, but there is a way that you can cut back on the amount of money the state taxes. This all comes down to choosing lump sum or annuity payments.
A lump sum payment means you’ll be awarded the entire aggregate winnings in one giant sum right up front. After removing taxes and fees, the leftover winnings are given to you immediately. The benefit here is that you can enjoy all of your winnings without needing to wait over time.
However, the year you receive the money, lottery winnings are subject to income tax (both federal and state). So when you take a lump sum, you’ll pay a lot of income tax.
This is why you might want to go for annuity payments, which pay out regular installments of your cash prize over about 30 years. This can save you money on taxes because the resulting tax bill spreads across several decades rather than upfront.
Other Advantages to Annuity Payments
Besides the fact that you can close the gap on the “house always winning” because you don’t need to shell out so much money right up front, there are other advantages to taking your winnings as an annuity.
One of the significant benefits is that it can prevent you from blowing through all your winnings at once. Something known as the “lottery curse” has happened to winners. Essentially, winners who take a lump sum often quickly use up all their winnings from irresponsible spending. Annuity lessens the odds since you can only have access to a portion of your jackpot every year.
How Does the Lottery Stimulate the Economy?
While the lottery system is self-contained, there are some indirect ways that you might also be contributing to your state, local, or federal government by playing the lottery.
For one, when you go to a lottery retailer to purchase a ticket, you might also be inclined to buy other goods or services at the location. This supports a local business, and the tax you pay on those goods can also contribute to the state's infrastructure.
Additionally, many rightfully treat themselves to large purchases after a massive lotto victory. These are also often taxed so that the state can gain a portion of lottery funds through your purchases.
Finally, in a similar vein, lottery winners might be inclined to share the wealth with their family and friends. If you purchase large gifts for the people in your life, you’ll need to be prepared to pay a gift tax. Generally, gifts over $15,000 per recipient will require you to pay taxes upwards of 18% to 40% on specific gift amounts.
In Conclusion
While you have a (slight) chance of winning a massive sum of money from playing the lottery, your state and federal government are likely to be bigger winners at the end of the day. By using tactics to encourage you to play the lottery even more often, the jackpot prize rises over time. And once it finally pays out, the state takes about 40% of the total winnings.
Those winnings get divided amongst commissions for the lottery retailer, the overhead for the lottery system itself, and the state government. Many state governments use these funds to support infrastructure, education, and gambling addiction initiatives.
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