Guaranteed Annuity Payments: Rates so High, Risk so Low (Part 3)

For the winner of a lawsuit or lottery, a structured settlement is easy to get into, but difficult to get out of it – like a lobster trap. Because the payments are set up by the insurance companies to be for a pre–determined period of time without any system to get an advance on future payments, there is no meaningful liquidity unless they wait. Claimants cannot go to a bank and get a loan based on these payments. The reason why a bank won’t lend against these payments is because they cannot foreclose on annuity payments the way they can, for instance, a home mortgage. Also, the Courts don’t want people to get out of the payment stream unless there is a compelling reason.

To sell one of these annuities, one has to obtain a court order. All of this takes time, knowledge of the legal system, and involves significant legal fees for the original owner, but not the investor in the secondary market. Because of this system, all sales are carefully monitored and underwritten so that at the end of the day there are no liens or encumbrances against the annuity policy so that annuity payments would not be able to be intercepted. This is where the secondary market, you and I as investors, come in.

The process for transferring payments from a claimant to you or me is very similar to buying a house. After a complete investigation of the contract, the insurance company sends out an assignment letter to the assignee (the investor) stating that he/she is the new owner of the future payments (structured settlement payment rights).

In order to make the future sale or transfer (for estate and/or gifting purposes) of the payments easy and without any delays, these transactions are set up to be serviced and processed through a third party – a large, well–capitalized title company. That way, there is no delay or publicity when a contract is sold or transferred at some time in the future.

The question comes up, “who are good prospects for this kind of conservative investment?”

The answer is, almost any individual or entity that wants a rate of return in the range of 4% to 7% with minimal risk – more than twice what you can get today from comparable investments with the same amount of risk. The fact that these investments have a great deal of liquidity to them in the secondary market makes a strong case for putting a portion of one’s portfolio into this asset group.

Although these annuities are totally tax–free to the Courtroom Settlement winner who originally got them, they are taxable to almost all other investors (except charitable institutions). Because they are tax–free to the settlement winner, the insurance companies are not required to send 1099’s to the investors who buy these from claimants.

For qualified retirement plans, there is no tax while the investment is in the plan. When any money is withdrawn from a retirement plan (excluding Roth Conversions), the proceeds are taxable as income. For purchasers of these annuities, it is generally believed that the payments should be treated like an annuity payment under Section 72 of the IRC – a portion of the payments would be principal (using the exclusion allowance) and the rest would be considered interest. Investors should get advice on this from their individual tax professionals. (The IRS does not have any published rulings as to the taxability of these annuities).

Remember, these are low risk investments guaranteed by insurance companies. You can safely take a lump sum of money sitting in a bank or money market; invest it in a secondary market annuity; and watch the money roll in at a much higher rate than you were getting before. Large return, low risk!