Guaranteed Annuity Payments:United States
Lottery/Courtroom Settlement winners who sell future payments from Existing Annuities
Guaranteed annuity payments from the wholesale secondary market receive 4% to 7% returns. How and why these guaranteed annuity payments can offer such a high return while minimizing risks substantially by cash flows guaranteed by the most secure insurance companies.
Most people today love a bargain. Just walking into a TJ Maxx, Marshalls, or Ross stores and you can see the joy on people's faces knowing they bought a shirt for $15 that was $100 down the street at the mall in Nordstrom's. The same thing can be done in finance, but most of the public does not know where to find these discounts.
In this day and age, when conservative investors are unhappy with the low rate of return on Certificates of Deposits (CDs), Government Bonds and Annuities, one question being asked is, "Where can we put our money that is extremely safe, and at the same time yield a high rate of return – at least double or triple what you could get at Bank of America with the same low level of risk?"
The answer: buy guaranteed annuity payments in the secondary market that lottery and Courtroom Settlement winners sell for "cash now," at a discount. This is a transaction that people have heard about on TV and radio, often from a different perspective, through ads by companies such as JG Wentworth and Peachtree Funding. These ads invite people who have lottery payments and structured settlement payments to sell these cash flow streams (annuities) at a discount in exchange for a lump sum payment.
These companies (Factoring Companies or FCs) then sell them in huge packages to European Banks and large pension funds. These securities are guaranteed by major insurance companies and States (for lottery payments). The guaranteed rate of return is 4% to 7% (effective interest rate) – more that TWICE what one could get at the bank using the same kind of risk parameters.
Sounds too good to be true,
How does the Guaranteed Annuity Payments work and what is the catch?
In the United States, the most litigious country in the world (94% of all lawsuits are instituted here), about $6 Billion per year is generated in legal settlements for personal injury or wrongful death claims that are settled so that the claimants (plaintiffs, annuitants) get their settlements in periodic payments over time. The payments, if set up under a provision in the law - IRC Section 5891 (c)(1), are totally tax-free and guaranteed by highly rated life insurance companies (and back-stopped by State Guarantee Funds).
For most people, this works out to be a wonderful arrangement, and in fact, there are about $100 Billion worth of these contracts in force with US carriers today. However, some of these claimants find that their circumstances change and they cannot wait 5 years for their monthly check, so they sell their future monthly checks at a discount. About $2 Billion of these settlements are sold to FCs each year at a discount of approximately 50% of their original purchase price. Thus, an investment guaranteed by a life insurance company at 3.00% could now be guaranteeing 6.00%, with the same benefits and assurances that the original purchaser enjoyed.
There has been some confusion among both advisors and their clients as to how these arrangements are transacted and regulated, and why the rate of return is so high when the risk is so low. For the winner of a lawsuit, it is very easy to get into a structured settlement, but very difficult to get out of it – it is like a lobster trap. Because the payments are set up by the insurance companies to be for a set 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. A bank cannot foreclose on annuity payments the way it can, for instance, when someone doesn't pay their 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. However, 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.
The process for transferring payments from a claimant to you or me and a new owner (investor) 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% - 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 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). In fact, 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).