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The skinny on secondary market annuities

Question: I am retired and would like to safely increase income. What is a secondary market annuity? Is it a suitable vehicle for putting a portion of retirement funds to safely increase guaranteed retirement income? Are there issues to be aware of with the secondary market annuities? How should this product be purchased? Thanking you in advance for any light you can shine on this topic. Ronald, Rhinebeck, NY 

Answer: Like so many retirees earning next to nothing on their fixed-income investment, you'd like to "safely increase guaranteed retirement income." Secondary market annuities -- also known as factored structured settlements -- offer lush yields in comparison to safe Treasuries, CDs and the like. But it isn't a product that will "safely increase guaranteed retirement income." My bottom line: Steer clear of the product.  

The time-honored insight holds: A higher yield means greater risks. I don't see anything "safe" about a secondary market annuity for the average retiree. 

These securities come at the end of a long daisy chain. Stripped down, the basic process essentially runs along these lines. Someone wins a wrongful death or injury lawsuit. The settlement is paid out through an annuity. Howeverhe beneficiaries need income now. They sell the annuity and its income at a big discount to a specialty company called a factoring firm. The factoring firm, in turn, transforms the stream of income into a packaged security. The security is sold by brokers to individual investors.

I think you can see that it's a market for genuinely sophisticated investors with both the means and the insight to diligently research the underlying product. 

Jason Zweig, the savvy investment columnist for the Wall Street Journal, offer a typically smart overview of the investment here.   

But as is so often the case when investments are promoted on the basis of high yield, these deals are unsuitable for most investors. Even in the rare situations when they might make sense, you must proceed with extraordinary caution.

The title of his article sums up well why most retirees and average individual investors should stay away from secondary market annuities: Another Can't-Miss Deal That Can Miss Spectacularly.

About the author

Chris Farrell is the economics editor of Marketplace Money.
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Dear Chris,
I made an effort to locate your phone number but was unsuccessful so I'm commenting here on your site below.
Your comment: "But it isn't a product that will "safely increase guaranteed retirement income." My bottom line: Steer clear of the product. " Your comment is without basis. Although there are serious risks that must be vetted prior to funding, including but not limited to; liens, levies, attachments, garnishments, divorce decrees and children. There are advanced searches that are performed by the factoring companies (usually attorneys) as well as our office and outside counsel prior to funding any case (LexisNexis, CT Lien Search, Pacer Federal Searches, CLEAR, credit reports etc...). I'm a financial planner as well as the COO of a broker dealer and we were made aware of these after liquidity dried up for the institutional investors in early 2009. We then began a 4.5 month due diligence process before placing our first transaction and we did it with our own money to fully understand the process and how they worked before recommending them to any investor. Every case we fund at Somerset Wealth Strategies is reviewed and approved by outside counsel prior to any funding and we never let the factoring company control our clients funds.

To your other comments (I WILL RESPOND IN ALL-CAPS SINCE I HAVE NO FONT OR COLOR CONTROL WITH THIS POST):
These securities come at the end of a long daisy chain (THEY ARE NOT SECURITIES, THEY CAN BE MADE SECURITIES BY POOLING, BUT WHEN WE PLACE AN INDIVIDUAL INVESTOR IN THE COURT ORDER THEY ARE NOT A SECURITY. THE PAYEE IS SELLING PAYMENTS RIGHTS (USUALLY JUST A PORTION OF THEIR PAYMENTS AT ANY GIVEN TIME) IN EXCHANGE FOR A LUMP SUM AND THEY MUST GO THROUGH USC 26 IRC 5891 IN ORDER TO ACCOMPLISH THIS (OTHERWISE THE PAYEE WOULD GET HIT WITH A 40% EXCISE TAX). Stripped down, the basic process essentially runs along these lines. Someone wins a wrongful death or injury lawsuit. The settlement is paid out through an annuity. However the beneficiaries need income now. They sell the annuity (THEY AREN'T SELLING THE ANNUITY, THE INSURANCE COMPANY OWNS THE ANNUITY AND THE PAYEE/INJURED PARTY/ANNUITANT OWNS THE PAYMENT RIGHTS. OUR INVESTORS ARE PURCHASING A PORTION OF PAYEES PAYMENT RIGHTS) and its income at a big discount (THAT'S A GENERALIZATION. MANY PAYEES ARE RECEIVING TOP DOLLAR FOR THEIR PAYMENTS, OFTEN TIMES UNDER A 7% DISCOUNT RATE. LIKE MOST GOODS OR SERVICES THOSE WHO SHOP AROUND AND NEGOTIATE GET THE MOST FOR THEIR PAYMENTS) to a specialty company called a factoring firm (THEY ARE NOT SELLING THE PAYMENTS TO THE FACTORING COMPANY ANY MORE THAN A LISTING AGENT IS BUYING THEIR CLIENT'S HOUSE - THEY ARE THE SELLER'S AGENT. The factoring firm, in turn, transforms the stream of income into a packaged security (THE CLOSEST ANY COMPANY COMES TO THIS SCENARIO IS JG WENTWORTH WHEREBY THEY TRAUNCH AND FUND MANY OF THESE, THEN SECURITIZE THEM AND TAKE THEM TO THE STREET IN AAA BOND OFFERINGS. THAT IS A SECURITY, BUT PLACING AN INVESTOR IN THE PETITION WHERE A COURT ORDER IS ISSUED TO PURCHASE VERY SPECIFIC PAYMENTS IN THEIR NAME IS NOT. The security is sold by brokers to individual investors. IF IT WERE A SECURITY IT WOULD BE REGULATED BY FINRA/SEC AND IT IS NOT IN THIS FORM. CAN IT BE A SECURITY, YOU BETCHA! BUT NOT IN THEN FORM. IT'S PLAIN AND SIMPLY A TRANSFER OF PAYMENTS VIA COURT ORDER FROM THE ORIGINAL PAYEE TO ANOTHER INDIVIDUAL OR ENTITY, BUT YOU DO NEED TO MAKE CERTAIN THAT YOU ARE WORKING WITH GROUPS THAT SPECIALIZE AND REPRESENT THE INVESTOR NOT THE SELLER. ALSO THE PERSON WITH THE FIRST COMMENT DIDN'T KNOW WHAT HE WAS SAYING, HE WAS QUOTING THE AMORTIZATION SCHEDULE BUILT INTO THE TVALUE ILLUSTRATION (THE INDUSTRY STANDARD). TAXES ARE UNCLEAR IN THIS ASSET CLASS SINCE THE INSURANCE COMPANIES DON'T ISSUE 1099s, THEREFORE WE SUGGEST EVERY INVESTOR CONSULT THEIR CPA PRIOR TO INVESTING. THAT SAID, THE STRAIGHT LINE ANNUITIZATION METHOD (A BLEND OF PRINCIPAL AND INTEREST FOR NON-QUALIFIED MONEY - SAME AS TRADITIONAL IMMEDIATE ANNUTIES) SEEMS MOST APPROPRIATE.

Lastly I was quoted by Jason Zweig in the WSJ article you reference and I very much agree that done incorrectly they can be very hazardous to your financial health, but so can anything if you don't do your homework or have the right people in your camp. Please call me prior to covering this topic again, I assure you I can be helpful. 800-813-4000.

Hello above, and 1 now below

I looked into these a few months ago after hearing daily talk radio pumping of them.
Though there is a risk of refusal to pay transferees, IMO the greater risk.. is getting paid!

The ones I saw had a tax structure that was Horrendous.
You paid taxes on near 100% of your payout the first few years and that slowly diminishes to near zero at the end of 10 -30 years.
You're paying taxes on or own money return (15-35%) immediately

So front-loaded is the burden it produces a Negative return IMO
And so bad I would gladly 'write' these myself shift my tax burden - guaranteed.
It's as if they have been Restructured by the writer TO shift the burden

And recommend NOT making recommendations until you are more familiar with them as the article is just a cursory glance.

Chris-
Your assessment that Secondary Market Annuities are more complicated than standard investments is absolutely correct. However, that alone is not a reason to disregard this marketplace, and your quick judgment to "steer clear" does not do justice to your readers. Properly structured, Secondary Market Annuities can form the basis of a very safe, high-yield fixed income allocation for individual investors. There are firms that have completely buyer-centric purchase processes in place that protect buyers with outside legal review, third-party escrow, and broker-dealer compliant oversight.

I would welcome a dialogue with you or with any reader on your site or elsewhere on the merits and risks of the marketplace.

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