635 / What is a secondary market annuity?

Most secondary market annuities (also known as “factored” structured settlements) are annuities that were originally issued pursuant to structured settlements, meaning that the defendant in a lawsuit (often a personal injury suit) is found liable and, rather than pay damages to the plaintiff up front, reaches an agreement with the court so that the plaintiff receives the right to receive guaranteed annuity payments over time. In many cases, however, the plaintiff needs the funds immediately and, through a court-approved process, transfers the right to guaranteed payments under the annuity to a third-party buyer for a lump sum.

The court approval process is necessary because, while the plaintiff has received the right to income under the annuity, the defendant technically owns the annuity contract. Through this process, the parties enter into an assignment agreement that is presented to the court, which will approve or deny the transfer based upon whether it is in the transferring plaintiff’s best interests.

It is important to note that failure to comply with this court approval process can result in imposition of a tax equal to 40 percent of the discount at which the product is sold.¹ In recent years, however, nearly all states have developed a standardized process that has made obtaining court approval much more simple.

A secondary market annuity is often able to provide the taxpayer with a higher than average interest rate because the selling plaintiff typically must sell his income rights at a discount. The interest paid out under the contract, however, is governed by the original contract terms, which may provide for a rate that is much higher than today’s market averages.