The Benefits of Using Your Self-Directed IRA to Fund a Structured Settlement
We’ve all seen the commercials urging recipients of structured settlements to get “cash now!” There are a whole lot of people in need of an immediate cash influx and are willing to sell their future stream of annuity payments at a deep discount. How can your Self-Directed IRA benefit from this development?
What is a Structured Settlement?
A structured settlement is typically the result of a lawsuit. When a plaintiff wins a lawsuit, that person is awarded monetary compensation, or damages, from the defendant. Defendants often agree to pay damages via a structured settlement. In this situation, a defendant would set up an annuity contract backed by a life insurance company so that damages would be paid out to the plaintiff as a series of payments over time. The payments include interest to account for inflation.
If the recipient of the payments needs “cash now,” they can sell their rights to future payments on the secondary annuity market for a single lump sum. Investors, such as your Self-Directed IRA, can then purchase the rights to the future annuity payments.
The lump sum that your Self-Directed IRA would offer for this steady income stream is based on the net present value of the annuity payments. Typically, it would be the net present value less some discount, which can be significant depending on the need of the seller. If the seller agrees to your offer, you may need to obtain a court order that would assign the future payments to your Self-Directed IRA.
The Benefits of an Investment in a Structured Settlement
Investing in structured settlements is a hot strategy right now. Opportunities exist not just with structured settlements from lawsuits, but with a number of other structured annuities such as lottery winnings or pension payments.
The potential benefits to your Self-Directed IRA include:
High rate of return. Your rate of return on investing in an annuity is determined using the net present value, or value in current dollars, of the future annuity payments. While the amount that you would pay for an annuity starts with the net present value, you wouldn’t pay that much. Your offer would include a discount to that value to make it worth your while. Thus, the rate of return on your investment depends on the amount of discount you get. Since annuity recipients are often very motivated to sell their future payments, they’re willing to sell at a large discount, making your potential return in the 4-8% range.
Ongoing income stream. Unlike an investment in real estate that provides rental income, the income from a structured annuity doesn’t come with additional expenses or property maintenance. It’s important to consider, however, how the payments of a particular annuity are structured – typically for the specific circumstances of the recipient. This means your ongoing payments may come at irregular intervals or in varying amounts. For example, an annuity could be structured such that the recipient receives small annual amounts for a certain number of years followed by a large lump sum at the end, or has a number of years in between payments.
Low risk. A structured settlement, in the case of a lawsuit, is carried out by an annuity contract backed by an insurance company. These insurance companies are typically highly rated in order for the court to approve them, which means that there’s minimal risk of annuity payment default. You can count on the payment stream, however regular or irregular, because the payments are guaranteed.
The Bottom Line
High rate of return with low risk? You may be ready to jump right into this investment, but you still need to do your due diligence. Investments that sound too good to be true often are. However, current demand within this type of investment strategy is high, so it may be worth considering for your Self-Directed IRA.