This is part two of a series on selling your rights to money in the future. These rights may arise from an:
- structured settlement,
- court judgment,
- court settlement,
- note payments or
- other contract rights for money in the future.
When the dollars you will receive and the dates for their payment are known values for the payments may be described with precision. When the payments are all the same size and the dates are uniformly separated the value may be expressed by resorting to single formulas. When the amounts and dates change then the formulas become more complicated. The formulas related to valuing these transactions are taught as upper level college courses, but you could take an online class here. It is impossible to teach an entire college course in a single blog post. Much less the issues related to the secondary market on annuities. (You can find a great book on that here.) The formulas generally reduce the comparison to a single number called the discount rate. You can look for their statement of the discount rate applied. You should then find someone competent to independently verify that the rate the state is actually the rate computed.
Sometimes the stream of payments provides for increases in future payments based on inflation, gains or losses in market value or consumer price index. Sometimes future payments are based upon you or another person still being alive on the payment date. Each of these factors add actuarial issues and market complexities that substantially increase the complexity of evaluating the economic value. That doesn’t mean that the experts can’t figure with mathematical accuracy the discount rate they will apply to their estimate.
In Alaska the current judgment interest rate is 3.75%. The current CD rate that investors get at the bank is 2.00%. The long-term rate of return on the stock market is only 10.5%. Annuities from places like Met Life are extremely secure. People that are getting this type of investment have modest expectations for their return on their investment.
The higher the discount rate, the smaller your current payout will be. The lower the discount rate, the higher your payout. You want the discount rate to be as close to the current interest rates. However, the first bid from an annuity buyer will likely exceed 20%. Most are in the 27% to 30% discount rate.
The annuity buyer has more transaction costs than simply purchasing your annuity. They also have the administrative costs of marketing their services so that can snag your money. They have the obligation to pay 40% excise taxes to the IRS if they don’t get a judge’s approval of the transaction. They have the obligation of hiring counsel to present their deal to the court system. They have the administrative burden of getting the annuity company to actually pay them. Those other costs, as well as their profit have to fit in the equation between their cost of capital and the amount that you get. The annuity buyers won’t pinch pennies, they’ll hire the most expensive attorneys in town to get the judge to sign off on the deal.
From a judge’s perspective, when considering whether the deal is reasonable, consider whether the discount rate reported is reasonable in relation to investments that you can buy.
Another way to consider the issue is the discount rate reflects the rate that they are earning interest on the money amount they are paying you. Should the annuity buyer earn 15, 20, 25 or 30% on what is essentially a fixed income CD type investment? If not, then how is it that their bid is fair.
Past Articles about My Money:
Future Articles about My Money:
- Alternatives to Selling My Money.
- They offered enough for My Money to get a new Snow Machine — What a Deal?
- Negotiation Strategies for Selling My Money
- I’m Selling My Money — But They Say We Have to Go To Court
- Picking an attorney to evaluate your My Money Sale
- 40% Excise Tax on Buying My Money
- Buyer’s Attorney Has no Conscience Will Help You Give Your Money Away
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