Know Your Discount Rate When Cashing in Your Structured Settlement Payments
The Time Value of Money and Structured Settlement or Annuity Transfers
The terms annuity and structured settlement are frequently used interchangeably. A structured settlement is a defined payment schedule released to the recipient of a lawsuit in the form of a single premium immediate annuity (SPIA). Understanding the time value of money should clear up any confusion as to why you'd receive less money than your annuity is scheduled to pay out should you decide to sell your structured settlement payments. The present value of future money is determined by the number of payments or cash flows due to be paid out in a single lump sum and the discount rate being used in the transaction. A payment of $100,000 payable in 2 years is certainly valued higher than that same $100,000 payment due in 20 years assuming the same discount rate is used in each instance. It's a rather simple concept to understand. The longer it takes for an investor to recover his or her investment, the less money that future amount will be valued at today.
Discount Rates Applied to Structured Settlement and Annuity Transfers
Anyone that is interested in cashing in an annuity should know the discount rate the factoring company is charging. For example (as of the date of this write-up) if you have a $200,000 payment scheduled for January 1, 2015 that you'd like to sell you'd receive $89,763.55 using a 19% discount rate. Nevertheless, that same amount due on precisely the same date applying a 15% discount rate would net you $105,072.08. Variances in the discount rate can have a significant impact on what you would be given in a lump sum. In this prior illustration just a 4% difference equaled $15,308.53! For that reason know what your discount rate is before you cash in your annuity and browse around for the best rate.
Use a Present Value Calculator to Check the Value of Your Annuity
You should utilize a present value calculator to determine what your lump sum payment would be at varying discount rates. For annuity transfers rates are usually anywhere from 10-25% thus it's wise to look around. There are numerous companies that invest in structured settlements and annuities; nevertheless several of them charge extremely high discount rates. Get the highest offer you can prior to cashing in. You may want to meet with an attorney and/or financial consultant prior to signing a contract just to make certain you are entirely knowledgeable of the terms of the exchange.
Length of Time to Complete a Transfer
Annuity transfers take an average of 2 months to complete. Essentially the process is: seller agrees to the offer for his or her structured settlement payments, seller signs the contract, lawyer files petition for a court hearing for the transfer of structured settlement payment rights, court hearing is scheduled, court hearing occurs, and the seller is funded with a lump sum presuming the judge approves the transaction. Certain states may be faster than others but the all around process is precisely the same no matter which structured settlement factoring company you choose. Single premium immediate annuities that don't stem from a lawsuit normally don't need to seek court approval. Generally these transfers can be achieved in as little as a couple of weeks. Generally these annuities were acquired as an investment or inherited. The annuitant may decide to cash in their annuity policy at some period for a lump sum. The amount offered may be a bit higher than with structured settlement annuities given that there are ordinarily no legal fees or legal work associated with the transaction.
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Deferred Annuities
In recent years, one investment option that is becoming very popular, especially among more 'prudent' investors, is an annuity. This is because annuities allow people to reap the benefits that trading in the stock market can bring without incurring the risks involved in stock trading. As a result, there have been different types of annuities that have been developed to cater to different markets. Some of these include retirement annuities and indexed annuities that cater to people nearing retirement and young investors, respectively. Among these types, people have other options with the structure of the investment plan, including the option of having the taxes deferred on the earnings from the investment plan. These annuities are called tax-deferred annuities.
How do they work?
If you decide to invest in a tax-deferred annuity, you do not have to pay taxes on the earnings you get from your investment until you decide to take out your money from the investment plan. This means that as time goes by, the income from the investment plan will grow faster as compared to annuities that do not defer tax payments. This is because this set up allows you to compound your earnings and reduce the taxes you would have to pay in the long run. People who invest in tax-deferred annuities also have the option of either paying for the investment in lump sum (single premium) or in monthly installments (flexible) without affecting the guaranteed earnings they receive.
Types of Tax-deferred Annuities
There are three types of tax-deferred annuities: the fixed annuity, the equity indexed annuity, and the variable annuity. The first two types are designed to guarantee you a minimum rate of interest on your investment without experiencing any loss on your principal investment. On the other hand, variable annuities are greatly dependent on market conditions, which means that it is the riskier option because you run the risk of losing your principal investment when the market does not perform well.
In recent years, a preferred investment option is to invest in annuities, which can be very profitable for all types of investors. Among the different types of annuities, one type that has become very popular is the tax-deferred annuity, which allows a person to defer tax payments on earnings up until he takes out money from the investment, which, in the long run, means higher growth potential of a person's accumulated earnings.
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When Not to Sell Annuity Payments
Just because you have the option to sell annuity payments does not mean it is always the best option. There may be circumstances that make the decision to sell annuity payments contrary to your best interests. Many people have unwisely sold their payments without considering the circumstances that make such a transaction risky. Listed below are the three scenarios in which you ought to be discouraged from selling annuity payments.
It's Too Soon
If you are a minor or the parent of a minor who is trying to sell annuity payments, reconsider. Courts will most likely deny an advance of a minors settlement except in instances of extreme need. A guardian has to be appointed to make certain the transaction is in the best interests of the minor and not the parent. It is also too soon to sell if your payments are very far away. $100,000 due in 2025 is not going to get you $100,000 today. As a matter of fact, you won't even get $25,000.
You Do Not Have a Good Enough Reason
Courts across the country are very interested in peoples reasons for selling annuity payments. Judges do their best to evaluate whether the transaction is your best option or not. Telling a judge you are turning in your monthly payments so you can buy a new car is an excellent reason if you want to get denied. Buying a home, paying for school, averting financial disaster, keeping a home, important medical needs, and the like are more valid reasons to cash in future payments.
It Will Cost You Too Much
If you have to give up half or more of your annuitys value, you better know for sure that it's worth it. That's a very expensive purchase you are making when you give up $100,000 to get $25,000. And if you spend $25,000 on a car that depreciates and breaks down in 5 years, you have so very little to show for your money. Investing in start up businesses, vacations, recreational vehicles, and entertainment items are often questionable reasons to sell annuity payments.
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Annuity Payments
Annuity payments are fixed monthly payments paid by an insurance company to the individual. The payment made must be a fixed amount paid at evenly spaced intervals of time. They are fixed for paying either at the beginning or the end of the period. Annuity payments are mainly paid yearly, semi-annually, quarterly or monthly. Some of the most common examples of annuities are car payments, pension, insurance premiums and mortgages. They are mainly ordinary annuity and annuity due. Ordinary annuity refers to fixed monthly payments at the end of each interval where the rate of interest compounds similarly to the payment. In annuity due, a fixed payment occurs at the beginning of the interval. Other types of annuities are fixed, variable and equity-indexed.
Fixed annuities are defined as fixed monthly payments and are considered to be low risk investments. Variable ones are payments invested in portions. Equity-indexed ones are lump sum payments paid to the insurance company.
Many people make investments as this enables the insurance company to pay a fixed amount of cash at regular intervals to benefit the life of an annuitant. When an annuity is paid to benefit the life, he or she is applicable to pay tax that equals the amount attributable to the income generated by the principal. Special tax rules are applied to qualified employees for retirement annuity.
Annuities are calculated based upon the following formula:
Formula 1: Payment = PVoa / [(1- (1 / (1 + i)n )) / i]
(this formula is valid if you know the present value)
Where:
o PVoa = Present Value of an ordinary annuity
o i = interest per period
o n = number of periods
Formula 2: Payment = FVoa / [((1 + i)n - 1 ) / i]
(this formula is valid if you know the future payment)
Where:
o FVoa = Future Value of an ordinary annuity (payments are made at the end of each period)
o i = interest per period
o n = number of periods