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In a world full of risky financial assets constantly fluctuating in market value, annuities are comfortably boring and secure. Annuities and secondary market annuities (SMAs) guarantee income of a specific dollar amount until death, like a pension or government retirement benefit, or for a defined period of time independent of stock market swings or variations in federal interest rates.

In 2020, annuity sales totaled $58.6 billion in the U.S. alone, a 2% rise from the year prior. Now more than ever, risk-conscious investors are turning to income annuities to craft a retirement strategy with peace of mind. 

Annuities provide steady, fixed income—often for the rest of the annuitant’s life. But receiving payments over decades isn’t an ideal situation for everyone. Luckily, secondary market annuity transactions let annuitants sell their future payments for a one-off, lump-sum payment, or a series of payments over a limited time horizon.

For retirees looking to diversify their investments and income streams, SMAs are a critical tool. However, they’re not without their caveats. In this comprehensive guide, we’ve compiled everything you need to know about SMAs before getting started with this asset class. 


What Are Secondary Market Annuities?

A secondary market annuity is a pre-existing annuity or structured payment whose collection rights are factored from the original owner. Once bought, the annuity payments are then legally reassigned to the acquiring party from a factoring firm at a discount.

Unlike traditional annuity products, secondary market annuities are annuities or annuity-like products previously awarded as lottery winnings or injury (tort) settlements that have been resold (i.e., factored) in the aftermarket to investors via a Qualified Order for a lump sum. 

In effect, secondary market annuities are long-term income streams that have been sold and transferred for an immediate cash payment. In other words, SMAs trade an extended source of income for a one-time cash infusion. 


What Is A “Secondary Market” vs. Regular Annuity?

You can think of a standard fixed income annuity as simply paying a third party to take your money and give it back to you gradually over time. For the privilege of repaying you, the annuity company keeps a sizable chunk of the payout for themselves in the form of fees. 

In this situation, you’re paying for the promise of being repaid in guaranteed installments—regardless of external market conditions—for, often, the rest of your life. Annuities are insurance products that hedge against the risk of outliving your wealth

As investments, secondary market annuities follow a separate logic. These are annuities that are sold to a third party (i.e., the acquiring investor) in the aftermarket for a lump sum payment. The transaction of secondary market annuities is mutually beneficial for the selling and the buying party since not everybody stands to gain from payments dispersed over many years.’

Legally, the courts recognize, in some cases, that the original owner of the SMA retains ownership of the annuity post-factoring. However, the factoring company that provides the SMA guarantees the transfer of payment rights to the acquiring party and is responsible for overseeing the income stream transfer. 


How Do Secondary Market Annuities Work?

There are a variety of SMA formats. Below, we’ve listed the most commonly transacted types of annuities in the secondary market. 


Structured Settlement Annuity

A “structured settlement annuity” is generally what SMAs refer to. Also known as in-force annuities or structured settlement derivatives, these annuity types transfer the rights of financial agreements from a negotiated lawsuit, tort, or contract to a new recipient. 

SMAs under a structured settlement format grants the buyer the exclusive rights to collect structured settlement payouts that were initially intended for the original owner. 

Note that there is some controversy regarding whether structured settlement investments packaged as SMAs technically qualify as annuities under the generally accepted definition. As such, structured settlement annuities do not carry the same legal and statutory protections as annuities provided by insurance companies. 

Regardless of their semantic properties, SMAs as structured settlements offer identical financial protections and serve the same investment ends as regular annuities.


Lump-Sum Secondary Market Annuity

Typically, secondary market annuities are packaged as one-time sales. Secondary market annuities are usually sold for a single lump-sum payment in exchange for a multi-year stream of payments. 

In most cases, lump-sum secondary market annuities involve the factoring of large windfalls spread over long time horizons. These often take the form of the following:

  • Lottery winnings
  • Insurance claims and payouts
  • Lawsuit settlements and tort damages
  • Estate inheritances


Single-Premium Immediate Annuity

A single premium immediate annuity (SPIA) is an annuity type that is funded by a single deposit. Recipients of SPIAs usually begin receiving cash payments within one year, which is why they are classified as immediate annuities. 

The difference between SPIAs and regular SMAs is that the former cannot be funded with multiple installments of several months or years. Therefore, SPIAs require significant cash savings before they can be purchased outright. 

For some, SPIAs replace bond allocations in retirement portfolios since they often serve similar ends as fixed-income assets. Unlike deferred annuities, SPIAs operate like long-term bonds because financial gains are realized almost immediately upon acquisition.


The Risks and Drawbacks of Secondary Market Annuities

Before investing in secondary market annuities, there are a few disadvantages and risks of which potential buyers should be made aware. Below, I’ve listed the three principal risks of secondary market annuities.

  • Illiquid Investments: An annuity is a long-term, fixed-income asset (or liability) that in many cases cannot be “cashed out” mid-contract and is simply not as liquid as many other financial products or asset classes. 
  • Inflation Risk: Although there are certain annuities that offer gradually increasing payments over time, they may not keep up with the inflation rate, which has averaged 3.1% annually since 1960
  • Need Attorney Review: Secondary market annuity contracts should be reviewed by a licensed, independent attorney with expertise in insurance and annuity products.
  • Penalty/Non-Compliance Risk: This risk is tied in with the previous since there are sometimes penalties and associated fees built into the fine print of an annuity contract. Investors can trigger penalties by violating the terms of the contract. 


Put simply, annuities can be long, complicated, and loaded with fine print that might catch some investors off guard. That’s why we strongly recommend consulting with a financial advisor and a qualified attorney before signing an annuity contract. 


Criticisms of Annuities & SMAs

As a category, annuities are sometimes derided for being convoluted, costly, and generating relatively “poor returns” compared to traditional asset classes. It’s worth noting, however, that SMAs do not generate returns at all, since they are a transaction of a defined long-term asset for an immediate short-term cash payment. 

Unlike stocks, annuities don’t catalyze growth in a portfolio. Even variable annuities, which allow investors to realize gains, often impose caps on gains. You also surrender control of the money invested or secured in an annuity, since the funds are then managed by the insurance company or the annuity provider. 

SMAs provide similar income security as corporate bonds at comparable rates, though they can sometimes cost more than bonds for lower yields. However, it should be noted that fixed annuities offer lifelong income whereas corporate bonds mature, in most cases, after 3 to 20 years. 


A Note on SMA and Annuity Criticisms

Many SMA and annuity criticisms can be avoided simply by thinking of fixed annuities as insurance contracts rather than financial investments. 

Rather than investing capital with the goal of building wealth, annuitants pay a premium for the guarantee of a stable income in perpetuity. Although these goals are not always at odds, they don’t lend themselves well to direct one-to-one comparisons with other investment vehicles.

When investing in secondary market annuity contracts, the projected returns should not be compared to stocks, bonds, ETFs, or mutual funds. Whereas the objective of these assets is to grow wealth through positive price action, the goal of SMA is to assure steady future income to assist with retirement planning and strategy.


Maryland Attorney General SMA Litigation (2010)

Investors should be cautious of purchasing SMAs from irreputable companies. There are several isolated yet notable cases of investors being defrauded by companies providing SMAs or irregular annuities, such as the case of the State of Maryland Office of the Attorney General’s 2010 lawsuit against Access Funding, LLC. 

As of late 2019, Marylanders who purchased factored structured settlements branded as “annuities” by Access Funding, LLC or Somerset Wealth Partners have still yet to receive the income payments to which they are entitled. Legitimate annuity and SMA contracts do not undergo suspensions during litigation.

The presence of bad actors underscores the fact that buyers must always exercise caution when purchasing SMAs, and that all annuity contracts should be reviewed by a legal professional before signing. 


“Losing” vs. “Winning” A Secondary Market Annuity Contract

Many investment types, including annuities and SMAs, have winning and losing parties. If you’re taking over the rights to future payments as defined by an annuity contract, then you can, in practical terms, lose the bet if you do not receive payments whose total value match or exceed what you originally paid.   


Losing Scenarios

Generally, you “lose” an annuity if the real investment returns market-wide (i.e., S&P 500 Index, DJIA, etc.) are much higher than those specified in your contract. Like every investment, there is an opportunity cost associated with investing in secondary market annuities and there may be more lucrative options elsewhere.

You can also lose out in an annuity if you die prematurely and thereby leave unrealized payouts on the table. However, some annuity and SMA contracts have built-in joint-life annuity provisions so that one’s spouse can continue collecting upon the annuitant’s death.

Winning Scenarios

You can “win” an annuity contract by outliving your birth cohort and exceeding the life expectancy that your insurance company or annuity provider estimates. If you continue to collect lifetime annuity payments beyond your expected mortality age, then you’re essentially collecting free money. 

You also “win” if real interest rates or inflation rates are kept below what your annuity contract assumes (i.e., annuity estimates 3% inflation and 4.5% prime rate, but inflation averages 2%, and the prime rate averages 3.5% over the duration of the contract). 


Benefits and Advantages of Annuities and SMAs

There are a host of benefits that come with income annuity investing and SMA investing more specifically. I’ve highlighted the main pros of secondary market investing below.

  • Peace of mind during retirement: At a time when you want to relax and enjoy the fruits of your labor, you shouldn’t have to worry about how the market is doing from one day to the next. Fixed annuities let you get paid a defined amount no matter what, thereby eliminating market anxieties.
  • Guaranteed long-term payments: Investing is rarely a predictable and easily forecastable endeavor, but annuities and SMAs provide regular, structured returns that make financial planning easier.
  • Potential inflation protection: Some annuities and SMAs have riders that adjust payouts according to fluctuations in the cost of living; consider adding an inflation adjustment clause so you don’t lose value year over year on your payouts.
  • Steady income in a low-rate environment: When interest rates are low, SMAs provide a stream of income that often outperforms bond yields, providing a stable alternative to traditional fixed-income assets.
  • Competitive rates of return: Even in today’s ultra-low-rate environments (i.e., 10-year Treasuries currently yield 1.68%), SMA products offered by John Hancock, USAA Life, and Berkshire Hathaway boast rates between 3.25% and 3.58%


When purchased from legitimate vendors, secondary market annuities can be rewarding investment vehicles. To see what qualified finance experts have to say regarding the upside of this asset class, consider reading our previous guide to secondary market annuities


Fixed vs. Variable vs. Secondary Market Annuity Structures

There are three types of annuities: fixed, which payout a predetermined and guaranteed sum in regular installments; variable, which payout fluctuating returns according to underlying market conditions; and secondary market, which are transferred payment rights from structured settlements.  

On one hand, fixed annuities are more like a type of insurance, whereas variable annuities are a type of tax-deferred investment vehicle. In the former, the annuitant gives the insurance company the risk of the market; in the latter, the annuitant assumes the market risk. 

Finally, secondary market annuities are securities that derive from factored lottery winnings, personal injury claims, or wrongful death lawsuits that are paid out in the form of annuities. However, the winner or recipient of the annuity needs money upfront, so they sell the future payments to a third-party factoring company who then securitizes the future income and sells it to investors as an SMA.


Are Annuities a Type of Pension?

You can think of fixed-income annuities as a form of insurance. Pensions are essentially annuities that your employer buys for you and agrees to pay out in your retirement. Therefore, it’s less that annuities are a type of pension, but rather that pensions are a type of annuity. 

Annuities can be more aptly compared to insurance products. Similar to how most insured drivers lose money on their car insurance, it’s still a sound investment since it protects against a potential disaster. Although the expected value of insurance is typically negative, you pay a worthwhile premium for protection, 


Secondary Market Annuities and Your IRA or 401(k)

We’re often asked how to invest in annuities through an IRA. In this case, simple annuity rollovers can be executed in alignment with the IRS Publication 575 regulations, provided that the annuity contract is distributed by an IRS-qualified retirement plan. 

Secondary market annuities aren’t so straightforward, since they vary widely according to the factoring company and provider. Generally, SMAs are eligible for inclusion in a variety of retirement accounts, including:

  • Self-directed IRAs 
  • Self-directed 401(k) plans
  • SEP IRAs
  • Roth IRAs


Before investing in a secondary market annuity, contact your self-directed 401(k) or IRA account custodian to see whether this asset type can be purchased and held in your tax-advantaged retirement account. 


Who Should Buy An Annuity?

Although annuities can be purchased by anyone, an ideal annuitant is someone who meets the following conditions:

  • Is retired or nearing retirement age (i.e., <10 years from their retirement date)
  • Does not already have an employer pension
  • Has a pension, but its payoffs are insufficient for sustaining one’s quality of life in retirement
  • A retiree looking to diversify their retirement investment strategy with low-risk assets uncorrelated to the stock market
  • Wants some portion of their savings to last until their death risk-free


Meeting any combination of the above conditions would make an investor an ideal candidate for an SMA. However, any investor interested in diversifying their portfolio and managing risk with fixed-income assets can find SMAs and annuities helpful. 


Where To Buy Secondary Market Annuities

If you’re looking to mitigate market risk during your retirement, secondary market annuities can be a safe harbor. 

Just as there are risks to buying annuities, there are as many risks associated with not buying them—for example, outliving your retirement savings, or having to weather the storm through a recession, downturn, or the bursting of a stock market bubble.  

It’s never a good idea to dedicate your entire net worth to a single asset class. This is as true of annuities as it of stocks, bonds, and other investment vehicles. Rather, annuities and SMAs are just one category of an effective retirement diversification strategy.

If you’re going to invest in this asset class, don’t be misled. There are shady factoring companies looking to sell high-risk structured settlements to vulnerable investors. For a legitimate secondary market annuity and a reliable source of retirement income, consult our list of the top annuity companies today. 


Secondary Market Annuities: Frequently Asked Questions (FAQ)

Uncertainty in the federal interest rate environment drastically lowered the demand for income annuities for most of 2020. Since variable annuities are impacted by stock market and interest rate conditions, demand for variable rate contracts dropped 28%. However, by Q4, demand for both annuity types rebounded to pre-pandemic levels.

The IRS calculates annuity taxes according to the pro rata principle, which is sometimes called the "exclusion ratio". If we assume that the SMA is purchased with after-tax dollars, the IRS acknowledges that taxes have already been paid on the asset. Therefore, annuity buyers are only taxed on the new earnings gleaned from the annuity and not the full value of the asset. In other words, the yield or interest earned on the annuity (above the principal) is considered taxable as investment income. The principal itself is not taxed twice.

When filing your tax return, you should apply the exclusion ratio to the interest earned on your annuity. The income and interest taxable is reported as ordinary income, and insurance companies report annuities on a 1099-R Form. For more assistance, consult this helpful guide from Intuit TurboTax.

There are plenty of trustworthy, time-tested factoring companies and insurance companies offering SMAs, including but not limited to Liberty Life, MetLife, John Hancock, Canada Life, and American General.

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