What is annuity prison and how does a secondary market annuity get you out of it? Well, let’s start at the very beginning. An immediate annuity gives you a steady income for a set number of years. Some even pay you for as long as you live. Generally, however, the deal is that once you plunk your money down in exchange for the guaranteed payments, you can’t get it back.
Then there’s the tax-deferred annuity. Here you put away money with the hope of having it available to help fund your retirement or some other need in the distant future. Unfortunately, if you want to get out of it completely or remove a lot of money early on, you could face steep surrender charges.
Secondary Market Annuities
So how can you get your hands on your cash? Annuity owners can use the secondary market to create liquidity from an asset that usually is anything but. In this article we’ll take you through three different scenarios in which a secondary market annuity might prove useful.
- A secondary market annuity can convert your no-longer-needed annuity into a lump-sum cash payment.
- Annuities in a qualified retirement plan and straight life annuities can’t be sold on the secondary market.
- When purchasing a secondary market annuity, be mindful of the tax implications of receiving a lump-sum cash payment.
Scenario 1: No Longer Need the Income
Betty took an early retirement offer from her employer. She used part of her severance package to buy a 10-year, guaranteed payout immediate annuity. The annuity’s monthly checks would cover her fixed expenses, such as a mortgage, property taxes, and health insurance. After a decade the payments would stop. However, by then Betty could start receiving Social Security and pension income, which would make up for the loss.
Like clockwork, every month the annuity company deposited a check into Betty’s bank account. But after one year Betty grew bored with retirement. She found a job that paid twice what she had made with her previous employer. Now she no longer needed the annuity income. Worse, as a portion of that payout was taxable, it was pushing her into a higher tax bracket—a problem she didn’t have prior to taking the new job.
Things looked bleak, until a friend told her about companies that buy annuities from people just like her. She called the firm, and a rep explained how firms in the secondary market buy annuities, then repackage them into securities and sell them to institutional investors. The price they would offer Betty for her annuity would depend on four factors.
- The total amount yet to be paid out
- The time over which that payout will be made
- The current prevailing interest rate
- The annuity company’s financial strength.
With the expert’s help, Betty received three bids for her annuity. She accepted one and received a check within four weeks. Betty then invested the money in a tax-efficient index mutual fund. Her account will have the potential to track the underlying index, plus she has reduced her tax bill and can use the fund to supplement her income in the future.
Scenario 2: Long-Term Plans Change
Harry bought a tax-deferred annuity three years ago with a windfall profit he made on a real estate sale. He figured he wouldn’t have to touch the annuity for at least 15 years, when he planned to retire.
Harry’s son owns a high-tech business and could use some additional cash for a new product he wants to introduce. As Harry is convinced he could make a bundle by investing in it, he wants to get out of his annuity and invest the proceeds in his son’s company. He asked the annuity company how much it would give him for his annuity, but he found out that after paying surrender charges, he’d end up with less than he invested.
Then Harry’s insurance agent told him about the secondary market for annuities. Harry ended up with 15% more than the annuity company had offered. Thanks to the secondary market, Harry was able to change the long-term plan he originally had for his money and invest in his son’s business.
Scenario 3: Inherited Annuities
Pam’s father recently died and left her the remaining 11 years worth of payments from a 15-year immediate annuity. Pam didn’t need the extra income, but what she did desperately need was a lump sum to help pay her son’s college tuition, which was due in two months.
The annuity company wasn’t interested in buying the annuity. However, after taking a discount based on prevailing interest rates, a secondary-market firm offered Pam a lump sum for the remaining 11 annual payments. This gave Pam the money she otherwise would not have had to pay her son’s tuition bill.
Before resorting to a secondary market annuity, check with your annuity company to see if there is a payout provision, as it could prove to be the better option.
Caution: Not All Annuities Qualify
Just because you own an annuity doesn’t mean you can always convert it into cash. Annuities that are in a tax-qualified retirement plan are ineligible; so, too, are straight life annuities, as the payments are based solely on your life expectancy and are, therefore, not guaranteed.
Before selling your annuity on the secondary market, take these four steps:
- Contact the company that sold you the annuity. As the industry continues to add more options, you might discover that your annuity has a payout feature you never knew about.
- Contact your financial advisor or insurance agent. He or she should be able to explain your options and help you get the best offer on the secondary market.
- Think about how much cash you need. You might only have to sell off a portion of your annuity. Then you could let the balance grow tax deferred or even delay the payments.
- Find out how much you will owe in income taxes if you sell your annuity. Don’t wait until you get the check in hand. By then it’s too late, and you might end up sending a big chunk of what you just received to Uncle Sam.
The Bottom Line
Things change, and you may no longer need that annuitized guaranteed income you had so thoughtfully set up for yourself. All is not lost, however. Tapping into the secondary annuity market is one method for you to sell your annuity at not too bad a loss (at the least) and meet your current needs or desires for cash.