Annuities do not have a reputation for being flexible, but you can often sell your annuity and get cash if you need to. Getting out of an annuity may be difficult – and expensive – so it’s not a decision to be taken lightly.
There are generally two ways to get a lump sum from your annuity:
- Sell your future annuity payments in exchange for a lump sum in cash today
- Cash out an annuity contract that you have control over (being mindful of taxes and expenses)
With both approaches, you might be able to sell part of the annuity (it’s not all-or-none) depending on the situation. Of these two, the second option is the easiest, but that option isn’t available for everybody.
Selling an Income Stream
Annuity buyers may try to take advantage – watch out for sharks. Credit: Elias Levy, CCBY 2.0
With some annuities, you’ve already started to get a stream of income, and there’s no way to cash out with the insurance company. Those payments are helpful because they’re guaranteed and dependable, but they might not serve your needs.
Your future stream of income is an asset. Just like a car, house, or business (which is also an income-producing asset), it has value and somebody might buy it. If you’d rather have a large chunk of cash than the promise of future payments, you can make a trade. You might trade the entire payment you receive each month, or you can trade just a portion of your monthly income.
Because you’re not cashing out with the insurance company, you’d sell your annuity in the “secondary market.” You’ll need to find a private, unrelated buyer to take the annuity – and several national companies are eager to do just that.
The Cost
When you sell your annuity payments, you get a lot of cash – so does it actually cost you anything? It certainly does. The only reason buyers in the secondary market will give you money is because they stand to make more money.
You’re basically dealing with investors who have extra money on hand, and they’re looking to make a return on that money. That’s fair enough – but you don’t want to get taken to the cleaners, and this market is notorious for taking advantage of people who want to sell their annuities.
You can more or less figure out how much you’re paying with a bit of math. The math (don’t worry – you can use an online calculator) used in these situations is based on a “present value” calculation: how much is a series of future payments worth?
Having money today is better than having money tomorrow – you already know that. The question is how much better? A present value calculator (here’s a link to one) will tell you if you just plug in the numbers. If you’re good with spreadsheets, you can also use the PV function in Excel or Google Sheets.
Example: assume you’ll get $1,000 per month for the next 15 years. That’s 180 months (or 180 payments), resulting in a total of $180,000. An investor demands a return of 10% (known as the discount rate on most calculators). As a result, the investor might pay you roughly $93,000 today in exchange for those payments.
Is 10% fair? Who knows? It depends on the economy, how badly you need the money, what you’ll put the funds toward, and what alternatives are available. You need to shop around and consult with your attorney and a trusted financial planner. Just be wary of paying too much. In years past, it wasn’t unheard of for people to pay 30% to get out of a structured settlement (which is almost certainly way too much). At 30% you’d get about $39,000 – a big difference.
Get quotes from several sources, and reverse-engineer those quotes with an online calculator: change the discount rate until the present value matches their offer – then you know how much they’re charging. Compare other aspects of the deal (fees, reputation, and so on), and decide what’s best. Remember that you can always walk away (or get funding another way, such as borrowing or selling other assets), and you can always decide to only sell some of your annuity income.
Structured Settlements
In some situations, such as a structured settlement by court order, you can’t just sell your payments whenever you feel like it. The annuity was set up by a judge for a reason, and the courts must approve changes to your arrangement – you’ll need to show that the judge’s concerns (whatever they were) can be addressed if you get rid of that future stream of income and take cash now.
Note that judges are not financial analysts, and they might not even be good at math. If a court approves your sale, that doesn’t mean you’re getting a good deal. Judges can and do approve bad deals – their main concern is whatever legal issues are behind the payments and the beneficiary’s basic needs. Many judges try their best to avoid seeing people get taken to the cleaners, but they can’t know everything about everything, and they can’t live your life for you.
How to Sell
To sell your payments, find a reputable buyer and evaluate the deal.
- Start by asking your attorney for a recommendation
- If your attorney or insurance agent does not have any suggestions (ask for their opinion of this strategy while you’re at it), search for companies that buy structured settlements and other types of annuity payments
- Get offers from multiple buyers and figure out exactly what you’ll pay each one
- Do extensive research on any buyer you’re considering – this is worth several hours of your time at least
- Evaluate alternatives, such as getting a loan or downsizing
- Decide whether or not to move forward
Other Types of Payments
Every type of annuity payment is unique – some can be sold and some can’t. For example, lottery winnings are relatively easy to trade for a lump sum (at a cost, of course). However, it might not be an option to trade future retirement benefits for a lump sum in the secondary market. Social Security benefits are not eligible.
Cashing Out
If you own a deferred annuity, it is fairly simple to get your money out. You can request a distribution from your insurance company and any available funds can be mailed or wired to you. Before you pull the trigger, it’s important to know that you may pay fees and be liable for income taxes (plus income tax penalties) when you cash out an annuity.
Cashing out is generally not an option if you have annuitized your contract or if you are receiving payments as part of a structured settlement. Cashing out your annuity is generally only possible when you are the annuity owner and have complete control over the contract.
When you withdraw from an annuity, you face the possibility of several potential expenses.
Surrender charges: your insurance company may charge early withdrawal or “surrender” charges when you pull money out. Fees are typically highest in the early years of an annuity (perhaps the first seven or so), but it’s essential to speak with your insurance company before you take a withdrawal. You might be able to take 10% of your initial investment per year without any penalty, and that’s worth evaluating as an alternative to selling the whole thing and paying a large fee. The longer you wait, the less you pay.
Income taxes: annuities have certain tax advantages – which means they also have strings attached. The IRS generally taxes income or gains in your annuity, and those taxes are triggered when you withdraw funds. Depending on the type of account (if it is a pretax retirement account, for example) you might owe taxes on the entire amount anyway. Distributions from an annuity are generally taxed as income – you typically don’t get favorable treatment such as long-term capital gains rates. Speak with a local tax advisor to understand the consequences before you take a distribution.
Tax penalties: the IRS wants you to keep funds in an annuity until “retirement age.” If you pull funds out early, it’s possible that you’ll have to pay additional penalty taxes on top of the income taxes described above. This effectively reduces the amount of money you have available to you, and might make other options more attractive.
Word to the Wise
Be cautious about giving up a future stream of income – it could possibly be the best thing for you.
Again, you really need to get advice from several trusted professionals, including an attorney, a financial planner, and a tax advisor. There is big money at stake, and businesses that buy annuity payments are eager to take a cut – this is easy money for them. Spending some money to protect yourself is in your best interests.
Remember that you’re trading a long-term benefit for a short-term cash infusion, and there’s no “Reset” button, so make your decisions wisely.