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A Primer on Secondary Market Annuities (SMAs)

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(EDITOR’S NOTE: Buying secondary annuities is a complicated process layered atop a foundation of traditional annuities, the specifics of which can also be complicated. In addition, this is a challenging time to try to buy a SMA because fewer are available, the result of changing market dynamics. Potential SMA buyers need to fully understand the product and the intricacies of the purchasing process. This Q&A answers key consumer questions about SMAs.)

Q: What is a Secondary Market Annuity (SMA)?

A: A SMA is a transaction in which the current owner of an annuity sells his future income steam to somebody else in exchange for a lump sum payment. SMAs most commonly originate from lawsuit settlements or lottery winnings.

When somebody wins a state lottery, for example, they usually don’t get the entire amount at once. They can take a much smaller lump sum or elect to have the entire amount paid as an annuity – a series of payments over time. It often works the same way in a lawsuit. Frequently, the individuals who end up with these annuities want the biggest lump sum possible, not a stream of payments. They can elect to sell their future payments to someone else in exchange for a lump sum payment today – a SMA. SMA payments are direct obligations of insurance companies.

Q: Why are some people interested in buying a SMA?

A: SMA sellers price the product at a discount to attract sales. This typically provides the buyer with a higher internal rate of return (a type of interest rate) than is available on a traditional annuity.

Q: What is this rate today?

A: Typically 3 to 5 percent annually – roughly 1 percentage point higher than traditional annuities.

Q: Is this good?

A: While the payment is higher than that of a traditional annuity, it is low by historical standards, and not just because interest rates are extremely low. Institutional investors, also buyers of SMAs for re-sale, have pulled back from the market in recent years, undercutting supply and pushing rates lower than they would otherwise be. Roughly six years ago, the same annuities paid 5 to 7 percent annually, and the decline accelerated in the last two years.

Q: What are the drawbacks to SMAs?

A: SMAs have zero liquidity. Traditional annuities, by contrast, have limited liquidity. If you want to exit a traditional annuity early, you can do so by paying a surrender fee. Most traditional annuities also allow buyers to withdraw about 10 percent of their principal annually without penalty. None of this is true with SMAs. Once the court order approving the annuity transfer is rendered, the transaction cannot be undone and there is no opportunity for periodic withdrawals. In addition, SMAs take time to find and sometimes are not approved by the court, usually because of an issue with the seller.

Q: Who does an SMA make most sense for?

A: It may be best for a grandparent who wants to set up what is essentially an inherence to grandchildren. Capitalizing on the time value of money, a grandparent could, for example, pay a steep discount today for a stream of payments to a grandchild far in the future. For instance, he or she could spend $25,000 on a deferred income annuity that in 20 years would pay a grandchild $231 a month for 30 years. That would be a total of $83,160 in payments.

A SMA might also make sense for somebody in their 30s willing to pay roughly the same for a prolonged period of income in 20 to 30 years. Although it would be difficult for this person to know the particulars of their financial standing far in the future, the extra income should make any situation better.

Q: What are the purchase amounts and typical terms of a SMA?

A: The price of a SMA typically ranges between $20,000 and $400,000. The amount depends on what the annuity seller will accept as payment and what a buyer is willing to pay. Terms usually range from five to 20 years.

Q: How do you buy a SMA?

A: The easiest way is to deal with a distributor of SMAs. These includes firms such as Somerset Wealth Strategies, Pacific Structured Assets and In-Force Annuities. You should also hire an independent attorney to walk you through the process. Make sure he or she is a specialist in so-called factoring transactions, which broker the sale of annuity payment streams between annuity owners and prospective buyers.

Q: Can somebody transfer or sell SMA payments in the future?

A: Typically, the answer is no. The new owner must retain the annuity contract for the duration of the income stream.

Q: Are SMAs safe?

A: Yes. The court process makes sure the annuity seller is legitimate and, as previously mentioned, SMAs are financial obligations of the issuing insurance company. Historically, insurance companies have been safer money havens than banks.

Q: Can a SMA be bought with IRA money?

A: Yes.

Q: If you die before a SMA runs out, would a beneficiary get the remaining payments?

A: You can’t name a beneficiary on a SMA. But the insurance company obligation to keep making payments continues and becomes part of your estate.

— Steve Kaufman

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