Understanding How Most Lotteries Invest Your Winnings ...

Understanding Securities
& Zero Coupon Bonds/Strips

As it appears on the US Treasury Web Site
&
If You're an Annual Pay Lotto Winner ...

How You Can Determine If You're Receiving All Your Monies

Originally Posted: Thursday, July 1, 2004
Revised: Saturday, July 3, 2004 -
Added: Winners can now contact me
for the interest rate at the time that they won

Since I posted the "If You Win page," I have received a ton of questions about investments, investments costs, zero's, strips and how to determine if, as a winner, you are receiving all that you really won. Hopefully this page will answer all your questions.

Important Info To Know First
If you win Lotto Texas and you've chosen annual pay, the Texas Comptroller purchases US Treasury securities (zero's coupon bonds / strips) with your winnings. You are "suppose" to receive all monies earned from those investments. And ... each of your 19 OR 24 investments do have CUSIP numbers which you'll read about in a minute.

The Mega Millions group also buys US Treasury Securities.

If you win Lotto Texas, you've won the amount in the jackpot prize pool.

If you win Mega Millions, well, you've won the amount they "advertise." For this game, they invest however much is necessary to give a return of the advertised amount or if you take CVO, they will pay you the "investment cost" - NOT the amount in the prize pool. This is NOT good for the People because they can easily under-estimate the advertised jackpot amount and this happens regularly. However, they do allocate 31.69% of roll sales to the jackpot prize pool.

Below you will find, in layman's terms, the basics regarding treasury securities, strips and finally, my advise on how to determine if you are receiving all of your monies. I would strongly recommend that all winners verify, on your own, that you are receiving all that your investments are actually paying.



The Basics of Treasury Securities

What are U.S. Treasury securities?

U.S. Treasury securities are debt instruments. The U.S. Treasury issues securities to raise the money needed to operate the Federal Government and to pay off maturing obligations - its debt, in other words.

Why should I buy a Treasury security?

Treasury securities are a safe and secure investment option because the full faith and credit of the United States government guarantees that interest and principal payments will be paid on time. Also, most Treasury securities are liquid, which means they can easily be sold for cash.

What types of securities do you sell to individual investors?

We sell Treasury bills, notes, bonds*, and U.S. savings bonds to individual investors.

What are Treasury bills?

Treasury bills (or T-bills) are short-term securities that mature in one year or less from their issue date. You buy T-bills for a price less than their par (face) value, and when they mature we pay you their par value. Your interest is the difference between the purchase price of the security and what we pay you at maturity (or what you get if you sell the bill before it matures). For example, if you bought a $10,000 26-week Treasury bill for $9,750 and held it until maturity, your interest would be $250.

What are Treasury notes and bonds*?

Treasury notes and bonds* are securities that pay a fixed rate of interest every six months until your security matures, which is when we pay you their par value. The only difference between them is their length until maturity. Treasury notes mature in more than a year, but not more than 10 years from their issue date. Bonds*, on the other hand, mature in more than 10 years from their issue date. You usually can buy notes and bonds* for a price close to their par value.

Treasury sells two kinds of notes, fixed-principal and inflation-indexed. Both pay interest twice a year, but the principal value of inflation-indexed securities is adjusted to reflect inflation as measured by the Consumer Price Index -- the Bureau of Labor Statistics' Consumer Price Index for All Urban Consumers (CPI-U). With inflation-indexed notes and bonds*, we calculate your semiannual interest payments and maturity payment based on the inflation-adjusted principal value of your security.

What are U.S. savings bonds?

Savings bonds are Treasury securities that are payable only to the person to whom they are registered. Savings bonds can earn interest for up to 30 years, but you can cash them after 6 months if purchased before February 1, 2003 or 12 months if purchased on or after February 1, 2003.

What types of savings bonds are available?

You can buy two types of savings bonds for cash: the Series EE bond or the Series I bond. You can only buy Series HH bonds in exchange for Series EE/E bonds and savings notes or when you reinvest the proceeds of matured Series H bonds. For more information on these types of securities and how to purchase them, visit our Savings Bonds website.

How do Treasury bills, notes, and bonds* differ from savings bonds?

Unlike savings bonds, Treasury bills, notes, and bonds* are transferable, so you can buy or sell them in the securities market. Also, bills, notes, and bonds* are electronic - they're not paper securities like savings bonds. You can buy Treasury bills, notes, and bonds* for a minimum of $1,000, and you can buy savings bonds for as little as $25.

How can I buy a Treasury bill, note, or bond*?

It's easy. Buy Treasury bills, notes, or bonds* either at one of the auctions we conduct or in the securities market. If you want to buy a Treasury security at auction, contact us, a Federal Reserve Bank, a financial institution, or a government securities broker or dealer. If you want to buy a Treasury security in the securities market, contact your financial institution, broker, or dealer for more information.

What is a Treasury auction?

Each Treasury bill, note, or bond* (except savings bonds, of course) is sold at a public auction. In Treasury's auctions, all successful bidders (we'll discuss bids in a little bit) are awarded securities at the same price, which is the price equal to the highest rate or yield of the competitive bids we accept. You can find a complete explanation of the auction process in our Uniform Offering Circular, which is in the Code of Federal Regulations (CFR) at 31 CFR Part 356.

How can I find out when an auction will be held?

About one week before each auction, we issue a press release announcing the security being sold, the amount we're selling, the auction date, and other pertinent information. This information is available from us and from your financial institution, broker, or dealer. Many newspapers also report Treasury auction schedules in their financial sections.

How can I participate in an auction?

Simply submit a bid for the security you want to buy. You can bid either noncompetitively or a competitively, but not both in the same auction.

If you bid noncompetitively, you'll receive the full amount of the security you want at the return determined at that auction. Therefore, you don't have to specify the return you'd like to receive. You can't bid for more than $1 million in a bill auction or $5 million in a note auction. Most individual investors bid noncompetitively.

If you bid competitively, on the other hand, you have to specify the return -- the "rate" for bills or the "yield" for notes -- that you would like to receive. If the return you specify is too high, you might not receive any securities, or just a portion of what you bid for. However, you can bid competitively for much larger amounts than you can noncompetitively.

How do I submit my bid?

Once we announce the auction of a security, you can submit a bid for an auction directly to us, to a Federal Reserve Bank, or through a financial institution, broker, or dealer. We accept bids by mail or, for current customers, over the Internet and by touch-tone phone. A financial institution, government securities broker, or dealer can also submit bids on your behalf. Although we don't charge fees to process a bid, some financial institutions, brokers, and dealers may charge for that service.

What is the minimum purchase amount for Treasury securities?

The minimum amount that you can purchase of any given Treasury bill or note is $1,000. Additional amounts must be in multiples of $1,000.

Do I have a choice as to where my Treasury securities are kept?

All Treasury securities are issued in what we call "book-entry" form -an entry in a central electronic ledger. You can hold your Treasury securities in one of two systems, TreasuryDirect or the commercial book-entry system. TreasuryDirect is a direct holding system where you have a direct relationship with us. The commercial book-entry system is an indirect holding system where you hold your securities with your financial institution, government securities broker, or dealer. The commercial book-entry system is a multi-level arrangement that involves the Treasury, the Federal Reserve System (acting as Treasury's agent), banks, brokers, dealers, and other financial institutions. So, in the commercial book-entry system, there can be one or more entities between you (the ultimate owner of the security) and Treasury.

What features does TreasuryDirect offer?

TreasuryDirect makes payments by direct deposit to your bank account and sends statements directly to you. We don't charge any fees when you open an account or buy securities. (The only fee we charge is a maintenance fee ONLY IF your account has a total par amount of more than $100,000.) TreasuryDirect also allows you to automatically reinvest most maturing securities. Although you have a direct relationship with us, your financial institution, government securities broker, or dealer can submit a bid for a security to be delivered to TreasuryDirect for you. For more information on TreasuryDirect, please click here.

What features does the commercial book-entry system offer?

In the commercial book-entry system, you'll maintain your relationship with your financial institution, broker, or dealer and potentially pay fees for their services. The commercial book-entry system allows you to easily buy and sell securities as well as, unlike TreasuryDirect, use them for collateral. You can also hold Treasury securities in stripped form, known as STRIPS or zero-coupon Treasuries, in the commercial book-entry system.

What are STRIPS or zero-coupon Treasuries? (Texas Buys Strips - More info below)

STRIPS, also known as zero-coupon securities, are Treasury securities that don't make periodic interest payments. Market participants create STRIPs by separating the interest and principal parts of a Treasury note or bond*. For example, a 10-year Treasury note consists of 20 interest payments -- one every six months for 10 years -- and a principal payment payable at maturity. When this security is "stripped," each of the 20 interest payments and the principal payment become separate securities and can be held and transferred separately. STRIPS can only be bought and sold through a financial institution, broker, or dealer and held in the commercial book-entry system.

How can I sell my Treasury security before maturity?

If you hold your security in the commercial book-entry system, contact your financial institution, government securities dealer, broker, or investment advisor. Normally there is a fee for this service. If you hold your security in TreasuryDirect, you can transfer it to an account in the commercial book-entry system or let us sell your security through our Sell Direct program for a modest fee.

How do I transfer my securities from one system to the other?

It's easy to transfer securities between TreasuryDirect and the commercial book-entry system. To transfer into TreasuryDirect, just ask your financial institution, broker, or dealer to handle it or click here. If you don't already have a TreasuryDirect account, you will need to create one before transferring any securities, however. To do that, just complete and submit a New Account Request to a Federal Reserve Bank. Likewise, if you want to move your TreasuryDirect securities to an account in the commercial book-entry system, you will need to create an account in the commercial book-entry system first. Contact your financial institution, broker, or dealer to do that. You'll also need to fill out and submit to your TreasuryDirect office a Security Transfer Request. Check with your broker, dealer, or financial institution about what wire transfer information you must include. You can download or order the necessary forms from the Internet, or get them by calling your TreasuryDirect office.

How do I receive my interest and principal payments in each system?

In the TreasuryDirect system, Treasury makes interest and principal payments directly to the bank account you choose. In the commercial book-entry system, Treasury's interest and principal payments may flow through several institutions on their way to you. For example, a payment could go from the Federal Reserve to a large bank to a smaller bank to your bank or broker before it gets to you.

What happens when my security matures?

When your security matures, we pay you the principal and the final interest payment through TreasuryDirect or the commercial book-entry system. TreasuryDirect allows you to reinvest the principal proceeds from maturing securities by mail, phone, or over the Internet.

How can I get more information about Treasury securities?

You can get information about Treasury securities on our website or your financial institution, broker, or dealer. If you're interested in TreasuryDirect, ask for our TreasuryDirect Investor Kit (PD P 009).

*The Treasury Department hasn't offered a Treasury bond since its decision in October 2001 to suspend issuance of the 30-year bond

The page can be viewed by clicking here.

Treasury STRIPS

The Treasury STRIPS program was introduced in January 1985. STRIPS is the acronym for Separate Trading of Registered Interest and Principal of Securities. The STRIPS program lets investors hold and trade the individual interest and principal components of eligible Treasury notes and bonds as separate securities.

What is a stripped security?

When a Treasury fixed-principal or inflation-indexed note or bond is stripped, each interest payment and the principal payment becomes a separate zero-coupon security. Each component has its own identifying number and can be held or traded separately. For example, a Treasury note with 10 years remaining to maturity consists of a single principal payment at maturity and 20 interest payments, one every six months for 10 years. When this note is converted to STRIPS form, each of the 20 interest payments and the principal payment becomes a separate security. STRIPS are also called zero-coupon securities because the only time an investor receives a payment during the life of a STRIP is when it matures.

How do I buy STRIPS?

The Treasury does not issue or sell STRIPS directly to investors. STRIPS can be purchased and held only through financial institutions and government securities brokers and dealers.

Why do investors hold STRIPS?

STRIPS are popular with investors who want to receive a known payment at a specific future date. For example, some State lotteries invest the present value of large lottery prizes in STRIPS to be sure that funds are available when needed to meet annual payment obligations that result from the prizes. Pension funds invest in STRIPS to match the payment flows of their assets with those of their liabilities to make benefit payments. STRIPS are also popular investments for individual retirement accounts, 401(k)-type savings plans, and other income tax-advantaged accounts that permit earnings to accumulate without incurring immediate income tax consequences. See the Federal income tax treatment of STRIPS section of this document.

The Department of the Treasury does not provide investment advice. Your investment advisor, financial institution, government securities broker or dealer, accountant, and/or tax advisor can discuss STRIPS in the context of your investment needs.

Which Treasury securities are eligible to be stripped?

All Treasury notes and bonds are strippable.

How is a Treasury security stripped?

A financial institution, government securities broker, or government securities dealer can convert an eligible Treasury security into interest and principal components through the commercial book-entry system. Generally, an eligible security can be stripped at any time from its issue date until its call or maturity date.

Securities are assigned a standard identification code known as a CUSIP number. CUSIP is the acronym for Committee on Uniform Security Identification Procedures. Just as a fully constituted security has it a unique CUSIP number, each STRIPS component has a unique CUSIP number. All interest STRIPS that are payable on the same day, even when stripped from different securities, have the same generic CUSIP number. However, the principal STRIPS from each note or bond have a unique CUSIP number.

For example, if several fixed-principal notes and bonds that pay interest on May 15 and November 15 are stripped, the interest STRIPS that are payable on the same day (for example, May 15, 2005) have the same CUSIP number. However, the principal STRIPS of each fixed-principal note and bond have a unique CUSIP number, and principal STRIPS with different CUSIP numbers that pay on the same day are not interchangeable (or "fungible").

In the case of inflation-indexed notes and bonds, the semiannual interest STRIPS that are payable on the same day (for example April 15, 2005) have the same CUSIP number. The principal STRIPS also have a unique CUSIP number. The CUSIP numbers for STRIPS from inflation-indexed securities are different from those for STRIPS from fixed-principal securities.

See the Federal rules pertaining to STRIPS on this website (31 C.F.R. 356.31) for more information on stripping. Also, see Appendix B to 31 C.F.R., Part 356, for an example of the adjustment that must be made to the value of a stripped interest component of an inflation-indexed security to make it interchangeable with the interest components of other inflation-indexed securities with the same payment date.

What are minimum par amounts for stripping?

Fixed-principal securities: The minimum face amount needed to strip a fixed-principal note or bond is $1,000 and any par amount to be stripped above $1,000 must be in a multiple of $1,000.

Inflation-indexed securities: The minimum face amount needed to strip an inflation-indexed note or bond is $1,000 and any par amount to be stripped above $1,000 must be in a multiple of $1,000.

Are STRIPS safe investments?

STRIPS are obligations of the Treasury and are backed by the full faith and credit of the United States.

Market prices of STRIPS fluctuate more than the prices of fully constituted securities of the same maturity. The market price of a STRIP reflects the fact that there is only one payment on a specific date in the future. The market price of a fully constituted Treasury note or bond reflects the fact that there is a series of semiannual interest payments and a final payment at maturity. The longer the maturity of STRIPS, the greater is the potential market price fluctuation.

STRIPS sell at a discount because there are no periodic interest payments. An investor's income on a STRIP that is held to maturity is the difference between the purchase price and the amount received at maturity. Long-term STRIPS have lower market prices than short-term STRIPS, because long-term STRIPS accrue interest over a longer period of time. For example, assume that three STRIPS are quoted in the market at a yield of 6.50 percent. The price for STRIPS with 25 years remaining to maturity would be $202.07 per $1,000 face amount; that for STRIPS with 10 years remaining to maturity would be $527.47 per $1,000 face amount, while that for 2-year STRIPS would be $879.91 per $1,000 face amount.

The total income from a STRIPS security is fixed at the time of purchase when the security is held to maturity. When STRIPS are sold before maturity, however, the investor could realize a gain or loss because the market price could be more or less than the purchase price plus the amount of interest (and the inflation adjustment to principal in the case of inflation-indexed notes and bonds) that has accrued between the time the security was purchased and the sale date.

Are STRIPS readily available?

There is a large and active market for STRIPS components of fixed-principal securities. Many brokers and dealers make markets in these securities and other market participants include pension funds, financial institutions, investment funds, and individuals. While the liquidity of particular issues may vary from time to time, in general a busy market exists for STRIPS with maturities from a few months to 30 years. A market has not yet developed for stripped components of inflation-indexed securities.

What is the Federal income tax treatment of STRIPS?

Generally, an investor must report as income, for Federal income tax purposes, the interest earned on STRIPS in the year in which it is earned. Inflation adjustments to principal on inflation-indexed securities must also be reported in the year earned. Income must be reported even though it is not received until maturity or the STRIPS are sold. Every investor in STRIPS receives a report each year displaying the amount of STRIPS interest income from the financial institution, government securities broker, or government securities dealer that maintains the account in which the STRIPS are held. This statement is known as IRS Form 1099 - OID, the acronym for original issue discount. The income-reporting requirement has meant that STRIPS are attractive investments for tax-deferred accounts, such as individual retirement accounts and 401(k) plans, and for non-taxable accounts, which include pension funds.

The income tax treatment of STRIPS also takes into account market discount and capital gains or losses, if any. Therefore, an investor would be well advised to review possible income tax implications before investing in STRIPS. For further information on the tax treatment of STRIPS and other zero-coupon securities, see Internal Revenue Service Publication 550, "Investment Income and Expenses" on the Internal Revenue Service website (http://www.irs.gov/formspubs/)

Can the STRIPS components be reassembled into a whole security?

STRIPS components can be reassembled or "reconstituted" into a fully constituted security in the commercial book-entry system. To reconstitute a security, a financial institution or government securities broker or dealer must obtain the appropriate principal component and all unmatured interest components for the security being reconstituted. The principal and interest components must be in the appropriate minimum or multiple amounts for a security to be reconstituted.

The flexibility to strip and reconstitute securities allows investors to take advantage of various holding and trading strategies under changing financial market conditions that may tend to favor trading and holding STRIPS or fully constituted Treasury securities.

Further questions?

If you have questions about buying or selling STRIPS, contact your financial institution, broker, dealer, or investment advisor. See also 31 CFR 356.31 for rules relating to stripping and reconstituting Treasury securities. If you have specific questions on the process for stripping or reconstituting Treasury securities, call the Bureau of the Public Debt at (202) 691-3550.

More ... click here

How to Determine If You're Receiving All Your Monies

If you previously won the lottery, chose annual pay, and the lottery is paying you the exact amount advertised. Well, first of all you need to know that in Texas, the official game rules have NEVER stated that the lottery would pay the amount advertised. That is, until Feb 2002 and even then it was "the greater of" either the prize pool or the investment cost.

Between Feb 2002 and May 2003, the TLC guaranteed the greater of either the amount in the prize pool or the costs to fund the advertised amount. However, the new 5/44 rule, effective May 7, 2003, changed to say that the TLC will pay the greater of either the amount advertised or the amount in the jackpot prize pool (39.104% of roll sales) for the first 4 draws in a roll only. After that 4th draw, you will receive the amount that is in the prize pool and this is GOOD.

To determine if you are receiving ALL monies the state has or is collecting from your investments (strips), here's what I suggest you do.

FIRST contact a financial adviser, broker, lender or The Lotto Report (972-686-0660) to find out what the zero coupon bond rate was on the first business day after you won. It wouldn't hurt to check several sources. Do not ask the TLC at this point.

SECOND, add up Texas roll sales (roll sales is defined as total sales for all draws leading up to and including sales for the draw that you won). Then take 32% OR 37.532% OR 39.104% of roll sales to determine how much you really won. The percentage for you depends on when you won - read on to see which percentage is applicable to your win.

If you are outside Texas, you will have to obtain draw sales and the official game rule from your state lottery. This is public information. IF I were you though, I'd ask a friend to obtain draw sales for the whole year that you won. Asking a friend to do this keeps you from being identified.

Simply send a letter to the lottery addressed to the lottery, ATT: FOIA Specialists (Freedom of Information). In your letter, simply say 'I would like to obtain total draw sales for all LOTTO draws held in 2001 and a copy of the official game rule that was in effect during 2001' or whatever year you need. You need the game rule so you can see what percentage of sales you "really" won. Be sure and include a mailing address for them to send it to - but not your address - By law, they cannot ask you why you want the information. Now to continue on for Texans ...

If you won between Nov 1992 - July 18, 2000, take 32% of roll sales to determine how much you really won. (If in another state, see the game rule for this information)

If you won between July 19, 2000 and May 3, 2003, take 37.532% of roll sales to determine how much you really won. This time frame is posted on my web site. (If in another state, see the game rule for this information)

If you've won since May 7, 2003, add roll sales and take 39.104% to determine your real winnings IF you won after the 4th draw in the roll. This time frame is posted on my web site. (If in another state, see the game rule for this information)

THIRD, take the gross payments that you have and will receive starting with year two (2) and add them up. Now divide the gross total by the rate you obtained. Now add your first payment to the figure. This figure should equal the amount in the jackpot prize pool or it should be very, very close.

FYI - The reason you start with year two (2) is because the lottery makes the first payment and then they buy investments with the balance in the pool to cover the next 24 years payments.

Do understand, rates can vary a little (brokering is competitive), so before jumping to any conclusions, simply ask the lottery what their rate was for your win and do the same calculations. IF the rate is a BIG difference, I'd dig deeper to find out why.

Also, keep in mind that the bigger the jackpot, the better the rate may be for the lottery which means that it may have required less money to invest.

If you won but chose CVO - Add roll sales and take whatever percentage of sales was applicable at the time. This is how much you should have collected.

To figure approximate rates: First, add roll sales and figure out what 39.104% of roll sales is - that's the winners share. Let's say that the lottery advertises the jackpot at $6 million. You simply divide 6,000,000 by the winners share: 6,000,000/$3,460,208 = 1.734%. FYI - I keep the winners share figure on my web site at all times. This figure can be found on one of three pages. The drawing results page (look under lotto Texas results), the IF You Win page and the Lotto Texas Money page.

In Conclusion

I feel very strongly that jackpot winners should receive ALL that they won from state lotteries. As it stands today, the states and the federal government are seeing what I consider to be more than their FAIR share of lottery sales.

If you want to contact me but are leary, that's OK. I understand. You can send me a note by US mail, include a self addressed stamped envelope, and ask me for the rate for the day you won. I will simply write the rate down and return to you. I will not contact you unless you want to talk to me. My address is: P. O. Box 495033, Garland, Texas 75049-5033. If you don't include the self addressed stamped envelope, you will not get an answer. I will not pay postage. OK?


Kiplinger- Lots of info on this page - More About Zero Coupon Bonds

 


The Lotto Report
Dawn Nettles
P. O. Box 495033
Garland, Texas 75049-5033
(972) 686-0660
(972) 681-1048 Fax
lottoreport@lottoreport.com