Dog Bites Man: Lottery Winner Goes From Rags to Riches to Rags

The headline of this recent Miami Herald article tells you just about everything you need to know. Talk about a "Dog Bites Man" story: the "lottery winning dream becomes a nightmare" stories are legion. 

A shockingly large number of lottery winners end up in financial ruin. National statistics show that about one-third of lottery winners ultimately file for bankruptcy, and up to 80% of U.S. lottery winners file bankruptcy within five years.

How can this possibly be? Most of the media focus on the symptoms. "Everybody wanted my money." "Everybody had their hand out." "[He] was both careless and foolish, trying to please his family" "[He] spent his fortune on a divorce and crack cocaine."

But all of this begs the question - why do lottery winners experience these symptoms? Presumably, at least some have read the ubiquitous "easy come, easy go" articles about their predecessors. More importantly, are their lessons for those of us in the much larger universe of non-lottery winners?

The answer (as it is with most rhetorical questions) is yes. We've seen it couched in both psychological and religious contexts, but the bottom line is this: we are wired to steward money we earn better than the money which falls into our laps.

While the most dramatic examples of money "falling into our laps" is lottery or gambling winnings, the most prevalent example is money received from an inheritance (hence the expression "Inheritance lottery."

In Bernard Goldberg's CBS prime time documentary Don't Blame Me, he chronicles the downward spiral of a former top pre-med student who dropped out and essentially lives under an expressway overpass. His undoing? Inheriting several million dollars with no guidance, management or strings attached. Of course, the psychological experts attributed it to the "condition" of "Affluenza."

In this context, "Affluenza" is simply the inability to handle a sudden gift of money. Some of it is undoubtedly attributable to lack of wisdom and experience: Are your kids ready to have as much wealth as your spouse?  Did you intend that your life savings be invested in college, a mortgage, a business, or a $100,000 red Porsche? 

Irreplaceable life experience might leave an heir to choose a college fund or home down payment over the red Porche. At least as important , however, is the "windfall" factor - receiving money not connected to work or effort. Remember the joke:

Q: How do you wind up with a small fortune?

A: Start out with a large fortune

One of the most successful men in history, Warren Buffett recognized this when explaining why

My family won’t receive huge amounts of my net worth. That doesn’t mean they’ll get nothing. My children have already received some money from me and Susie and will receive more. I still believe in the philosophy – Fortune quoted me saying this 20 years ago – that a very rich person should leave his kids enough to do anything but not enough to do nothing.

Families who preserve their wealth for generations understand this. Wealth is handed down in a strategic - not haphazard - way, with guidance, limits and protection.  A large unmanaged inheritance can often be worse than nothing at all, because money without management is not a blessing but a curse.

When is a 35% Gift Tax a Bargain? Right Now!

It's not for everyone, but for a lucky few - particularly those with grandchildren, the 35 per cent gift tax may be the biggest bargain in history. The most recent New York Times Wealth Matters, A Year to Give to Your Heirs, and Save on Taxes, explains why. 


In short, if you can't pass wealth estate tax free by dying this year, you can do it at a bargain  gift tax tate instead of waiting until January 1, when the rate shoots up to 55 percent.


But wait, there's more! Uncle Sam knows most of us prefer giving to grandchildren, so he (through Congress) enacted a Generation Skipping Transfer tax, a tax equal to the estate tax which is levied on top  of the gift tax and estate tax.

Even in the 2001-2009 world of increasing exemption amounts (from $1,000,000 to $3,000,000) and decreasing tax rates (from 55 percent to 45 percent), gifts to grandchildren over the exempt amount could incur a 100 percent tax. Under current law, when the exemption and rates return to the 2000 levels, such a gift could incur a tax of 140 percent. In this context, a 35 percent tax looks like a real bargain.

But letting the tax tail wag the dog is not always the most prudent choice. From a purely tax standpoint, you can avoid the Generation Skipping Transfer tax in 2010 by leaving a gift to grandchildren outright, rather than leaving the gift in trust. But is that a good idea? A trust beneficiary's inheritance can be protected from creditors, predators,  divorce and even poor judgement. An outright gift - even one which avoids the extra Generation Skipping Transfer tax - can be lost in the blink of an eye.

Which is more important? Like so many other estate planning questions, the best answer is "it depends." Specifically, it depends on your particular circumstances.