Secondary Market Annuities
Although Secondary Market Annuities have been around for a while, it’s interesting that many investors overlook them as a solid investment with lower risk than other traditional investment vehicles. A Secondary Market Annuity (SMA) is part of a transaction where a current owner of an income annuity sells or trades their annuity and its future income payments for a lump-sum payment from the buyer.
What is an Income Annuity?
When an individual owns an income annuity, it means they can collect annual income payments for the rest of the owner’s life. Some typical examples of income annuities and the income stream they provide might be insurance payments, lottery payments, payments from a legal action settlement, and even money that is left to a beneficiary of a will.
For some people who own SMAs, getting their annuity payment right away instead of receiving annual payments over a period of time is more beneficial depending on their circumstances. Buy selling the annuity for a lump-sum fixed price, the annuity owner can collect the payout right away.
How does Purchasing an SMA Work?
In most cases, SMAs are purchased from the owner by using an intermediary or even the courts. Generally, SMAs are underwritten by insurance companies who carry ratings from an insurance rating service like A.M. Best or Standard & Poor’s.
The SMA buyer expects to collect annual payments plus interest from annuities they purchase which is specified in the terms of each annuity purchased. Since the SMA is purchased at a discount for a lump-sum payment, these annuities typically pay a higher yield than traditional annuities. The average payout term is from five to twenty years but can be negotiated up or down in terms of the length of the payout. Generally, SMAs with a deferred start date or that has a longer payout term will deliver the highest yield.
Types of Secondary Market Annuities
Secondary Market Annuities (SMA) are known by several names.: Secondary Market Income Annuities, Settlement Annuities, and In Force Annuities. All three are basically the same thing. They are packaged cash flows being sold by their owners who have elected to sell the periodic payments for a lump sum. Consequently, it is not an agreement between the purchaser and an insurance company, but rather an agreement between the purchaser and the recipient of a stream of cash, facilitated by an attorney and a broker. Here are the most common SMAs:
Structured Settlement Annuities
Oftentimes, the victors of a legal action relating to mishaps such as slip and fall claims, vehicle accidents, work-related injuries, etc., decide to take their settlements as periodic income payments rather than taking a lump sum. This is advantageous to the recipient because many are disabled and need a steady steady flow of income. Additionally, the IRS considers these payments to be tax-free.
However, situations occasionally change for the victors of these legal cases and might change their minds later and prefer a lump sum. The seller can then provide the services of a factoring organization. The factoring organization will then make an offer to purchase the future income and then discounts the rate on the future income stream and makes it available through annuity brokers. These brokers can then promote these annuity packages for an investor to purchase.
The seller in of the annuity then petitions the court who originally awarded the payments to transfer future payments to you as the buyer. The entire process can likely take up to 90 days for the transaction to be completed. It’s important to note that if the court process is not followed when transferring the annuity payments, there will likely be a penalty levied by the IRS.
Lottery Payments
Oftentimes, individuals who win the lottery prefer to take the annuity option. Then again, many lottery winners later change their minds and decide they’d prefer the lump sum. Similar to setting up a structured settlement, the owner of the annuity would contact a factoring company. If you decide to purchase a lottery payout, you still need to go through a court process which will then assign the periodic payments to you. This is a vital security measure which is very important to the process.
Although with a structured settlement the IRS considers the payments to be tax-free, it’s not the same for lottery payments. The lottery commissions is required to withhold state and federal taxes from the payments you will be receiving. To reclaim some of the withholding, you will need to file a tax return in the state where lottery payments originated.
Why Consider a Secondary Market Annuity?
If you are considering buying one or more SMAs, it’s important that you use a broker who has the experience needed because transactions can be cumbersome. The good news is the yields that SMAs produce can be a boon to your retirement strategy. Some important benefits to consider are:
- Superior credit quality and higher yield than traditional assets
- Low fees and zero volatility
- Purchase an SMA with cash or qualified IRA funds
- No buyer suitability test or age restrictions
- No ongoing administrative or investment management fees