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Plan on Winning That Powerball Jackpot? A Little Advice

Tuesday, 27 Nov 2012 | 11:50 AM ET
David Muscroft | Age Fotostock | Getty Images

What would you do with half a billion dollars?

The web today is filled with fantasy stories about what kind of private jet or private island or yacht or diamond tiara you could buy if you win the jackpot in the upcoming Powerball drawing.

But going on a shopping binge would only turn any of these dreamers into the latest in a long line of ruined lottery winners. They would do better to follow the advice of experts who make a living advising the rich on how to preserve and manage their fortunes.

Here is their advice on what you should do with a $500 million jackpot.

Pay Taxes. The first decision you'll have to make is whether to take your prize in a lump sum or in multiple annual payments (usually spread over 20 years or more). Wealth advisers say the Powerball winner should opt for the lump sum – partly for tax reasons, but also for planning. The lump sum for the $500 million jackpot would be about $327 million.

Lottery winnings are taxed as ordinary income. Since tax rates are likely to increase next year, you can take the lump sum now and pay this year's lower tax rates. If the top rate goes to 39.6 percent from this year's 35 percent, paying this year's rate would save more than $16 million. (Read more: The Millionaires Who Pay the Highest Tax Rate).

The estate tax is also likely to go up. So if you opted for annual payments, and you passed away before the payments were all made, the total value of your remaining payments could be subject to the higher estate tax.

Plus, advisors say, the lump sum can be put in a trust or other planning vehicle.

Make a gift. Under current tax law, couples can give $10 million as a gift, tax-free. After that the rate is 35 percent. Next year, barring a "fiscal cliff" deal between the White House and Congress, the lifetime gift-tax exclusion for couples goes from $10 million to $2 million and the rate goes to 55 percent.

So if you're planning on sharing with friends and family, best to do it before Dec. 31.

Cool off. Sudden wealth has a way of ruining people lives, and there are plenty of stories of lottery winners going bankrupt, getting scammed by friends and fraudsters and going overboard with spending, drugs or other pleasures.

You can limit those risks by taking a "cooling off' period. Once you get the check, advisers say you should put all the money into a low-risk money market fund or savings account and leave it alone.

Make a Plan. Once the money is in the bank "cooling off," hire a financial adviser or wealth planner who will help you create a spending plan and investment plan. While most people can't imagine blowing $327 million, it's easier than it looks.

"You get a corporate jet and the crew, and you want to add couple of million-dollar homes and pretty soon you can exhaust it," said Charles M. Aulino, director of financial planning for the Glenmede Trust Company. "They need someone to walk them through the spending scenarios and know where those bookends are."

Once you do that, and know your income needs, you can develop an investment plan. That, according to wealth advisers, should include the usual preservation-oriented mix of bonds, stocks and alternatives. (Read more: What Capping Tax Deductions Would Cost the Rich)

Then, and only then, can you go out and buy those ten Ferraris and diamond tiaras for your friends.

-By CNBC's Robert Frank
Follow Robert Frank on Twitter:
@robtfrank

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  • A reporter and editor, Robert Frank is a leading authority on the American wealthy for CNBC.