You may have seen the commercials on TV about selling your annuity for cash. This is a business format that’s about as old as annuities themselves. These companies will offer to buy a stream of future payments that your annuity provides from you in exchange for a lump sum of cash. One problem is that these transactions are usually designed to make money for the company buying your annuity, rather than ensuring you get the best value for that annuity. Selling your annuity might seem like a good idea in a pinch, but in the end, it could cost a lot more than you anticipated.
What Happens in an Annuity Lump Sum Sale?
While most companies who buy annuities will have you believe that this is easy, the sale of an annuity can be actually quite complex. What happens is you submit for a quote and the company buying the annuity will review that annuity’s cash value. After that analysis, it will make you an offer, which could be as low as 50% of the cash value of the annuity. Generally, the longer the annuity schedule, the lower the payment. This is often because the insurance company is using a present day value in determining the offer.
A present day value is simply the value of future dollars in today’s money. If you invested $50 into a stock today, it might be because someone told you it could have a future value of $100. This future value represents the total amount received after all the interest is earned on it. Sometimes, in an annuity purchase, the company doing the purchase will do this calculation backward. Instead of receiving the amount your annuity company would have paid out eventually, you’ll receive a portion of the present day value of that amount.
This means if you purchase the annuity, rather than inherit or win it, it’s entirely possible that you could receive an offer lower than the premium you originally paid in. Third-party annuity sales are typically designed for people who didn’t have a choice in receiving an annuitized series of payments, like someone who received a settlement from a lawsuit or won a lottery. However, if you’re selling an annuity you paid for, then any lump sum payout you receive is likely going to cause you to take a loss.
In addition, these sales can be very complicated and not nearly as simple as the annuity purchase company would have you believe. You might even need a judge to sign off on your annuity sale. To get around that, the company may try to structure your lump sum as a loan from the company taking the annuity.
The high fees incurred in these types of annuity buyouts are often comparable with something you’d see in a payday advance. As a result, it’s usually advisable to not sell your annuity to one of these companies and instead, look into alternatives.
The Alternatives to a Lump Sum Cash Out
A sale to one of these annuity purchasers is often the last option when it comes to getting a lump sum out of your contract. There might be other options within your contract that you may have overlooked.
- Borrowing from your annuity. Some insurers will allow you to borrow a lump sum against your own annuity. This provision is rare in contracts, but can be found in older annuities. In this case, you will likely be charged an interest rate for the loan, but because the proceeds are proceeds from a loan, they won’t be taxable.
- Using your annuity as collateral for a loan This is different from borrowing from your annuity because you’re borrowing from a third-party, such as a bank, and using the annuity as collateral. Interest rates and terms will vary widely based on the lender and your own financial status. Keep in mind, though, that if you are unable to make the loan repayments, you may lose your annuity to the lender.
- Surrendering your annuity. This might not be an option if you’re dealing with an immediate annuity in which payments have already started, but could be possible in the case of a deferred annuity. Note that surrendering an annuity will come with its own set of fees and restrictions, and surrender charges could result in a loss of principal and any previously earned interest.
- Transferring from a deferred to an immediate annuity. This alternative might allow you to create an income stream from your deferred annuity earlier, while at the same time, allowing you to take advantage of certain tax breaks. Transferring your deferred annuity to an immediate annuity qualifies as a tax-free exchange under IRS Code 1035. You will only have to pay tax on the regular withdrawals, provided you’re older than 59½.1
- Taking income from a deferred annuity. If you own a deferred annuity, you may be able to take income payments or withdrawals from it. While you will ideally want to avoid surrender charges, many companies will allow you to take a portion out of your annuity’s cash value, such as 10%, each year without incurring surrender charges.
The companies who buy out annuities make their money on paying the least for the most amount of ongoing income. As a result, that annuity might only be worth about half of what it used to be worth if you sell it.
Instead, consider using the services of a qualified financial and insurance professional to help you find options for accessing your annuity value. One of the representatives in Retirement HQ’s network can help walk you through this process and help you avoid taking a big loss.