Secondary Market Annuities (SMAs) Can Offer Higher Yields

by Hersh Stern - Revised Monday, April 22, 2024

With prolonged low interest rates, you may be seeking financial products that provide higher yields and more income while still offering security. If so, secondary market annuities are an alternative to bank CDs and other traditional fixed-income investments that you may want to explore.

Your profile matches that of the ideal secondary market annuity buyer if you seek above-average returns with limited risk and have enough resources to be able to tie up funds in an illiquid investment.

Secondary market annuities are attractive because they offer you the chance to gain a monthly income flow for periods of varying length, as long as several decades, at a cost that is less than a comparable original issue annuity with high a level of safety.

These annuities come from people who bought them perhaps as an investment or as part of their retirement portfolio. Or they represented the winnings from a lottery or an award in a legal settlement. As with other annuitized vehicles, the income from these was structured to be paid out in fixed amounts over a long period.

But the original holders of these annuities found they either could not or did not want to wait. Rather than receive the money over time, they wanted a quick lump sum cash payment. This could be because of a financial hardship or a desire to get the money faster so they could buy a home or start a business.

To facilitate the sale of their annuitized income stream, they were willing to accept less than the full or face value of their contract. This discount is the source of the good deals that you can find among secondary market annuities.

In theory, the process of buying a secondary market annuity is straightforward. You as the buyer take over the right to receive the future payments under the existing annuity.

In practice, it requires you to exercise diligence and work with an agent who has expertise in this area because a court has to approve the transaction and the issuing insurance company has to agree to it as well. There are many complexities that must be handled correctly. If the income stream is from a lottery win, the state’s lottery commission also is involved. Buying a secondary market annuity is not an instantaneous process, taking generally 10 to 45 days.

Determining the purchase price for your secondary annuity involves calculating the present value of the future payments. The yield reflects an anticipated funding date, when the annuity makes its first payment and how long payments continue.

Typically the average present value of these annuities ranges between $50,000 and $500,000 for terms from 5 to 20 years. You will generally find that yields are higher for deferred start dates and longer payment periods.

When the transaction is complete, you will usually receive payments from the insurance company that issued the annuity, which makes it important to assess whether the issuer has an excellent credit rating.

It’s important to understand the disadvantages you face in secondary market annuities. First, they are not liquid or easily sold, and your rights as a secondary market annuity holder are typically not transferable. That means you must retain the contract until the end of the term. The tax aspects can also be complicated so you should work with a trained tax specialist or accountant.

Another risk – similar to the risk with all fixed annuities – is that you are locked into the terms of the annuity. So if interest rates rise, you will not receive any benefit from that and the value of your annuity will be diminished.