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What is an annuity loan?

An annuity loan is a situation in which an annuity holder will borrow money against the value of his/her annuity contract. It can allow people to access funds without going through the process of cashing out their annuity, which may leave them exposed to taxes and penalties.

Annuity Loans vs. Selling Your Annuity

 

Choosing whether to sell or take out a loan against your annuity can be a tricky decision. While there are benefits to both, the ultimate decision should be based on financial considerations, such as your ability to pay back an annuity loan in a timely manner. This article will review some of the major issues you should consider before making a final decision.

Annuity Loans

When can I take out an annuity loan?

With a deferred annuity, the annuity holder makes regular payments to their insurance company toward the purchase of the total annuity contract. Once that person reaches retirement age (currently 59 ½), the annuity will pay them a set amount of money each month.

However, before the individual reaches retirement age, they can borrow against the cash value of the annuity contract and the loan must be repaid with interest over a set amount of time (typically five years).

How does the process work?

Before the loan can be initiated, the borrower must submit a request to the insurance company that issued the annuity contract. If approved, the loan will be processed and the borrower/annuity holder will receive a lump sum loan and must make payments until the balance is paid off. Most annuity providers will allow annuity holders to borrow up to 50% of the cash value of the annuity. However, each annuity provider has different terms and conditions, so it’s important to research the available options.

What are the advantages?

One positive aspect of an annuity loan is that it allows the borrower to avoid paying “surrender charges.” When someone opens an annuity contract, they will pay a surrender charge if it is canceled within a set amount of time. These surrender charges will sometimes wipe out any gains the annuity holder has accrued through the contract. However, with an annuity loan, the borrower does not have to pay surrender charges.

An additional benefit is that the borrower can avoid taxes and early distribution penalties. For example, if an annuity holder sells their annuity before reaching age 59 1/2, they will be charged a 10% “early distribution” penalty on the amount withdrawn. Also, there will be tax implications for the annuity sale. An annuity loan can help avoid these charges.

What are the drawbacks/pitfalls?

Although it seems that an annuity loan is a convenient way to get cash in hand, there are some drawbacks. For example, if the borrower doesn’t repay the loan in the specified time frame, it will be deemed a “distribution” and he/she will be subject to an early distribution penalty, which is usually 10%. Also, borrowing money against the annuity will hurt the ability of the investments to grow over time and the borrower may be forgoing potential earnings.

Selling Annuities

How do I sell my annuity?

There are a few different options available when seeking to sell an annuity. The most common are: 1) entirety, 2) partial, and 3) lump sum.

1) Entirety – selling an annuity pays out the entire investment as a lump sum and forfeits the annuity holder’s ability to receive future periodic payments. This is the most straightforward way to sell an annuity.

2) Partial – a partial buyout allows the seller to sell a portion of his/her annuity payments and still receive periodic income without forgoing the tax benefits. For example, if the seller needs money immediately, he/she can sell years 1 – 5 of their annuity payments in exchange for a lump sum. After those five years have lapsed, the periodic payments will continue. Also, if the seller needs additional funds, he/she can buyout another portion of the remaining payments in exchange for lump sums.

3) Lump Sumlike a partial buyout, an annuity holder can choose to sell a portion of the annuity in exchange for a lump sum. This approach gives the seller more flexibility in choosing the amount of the lump sum, which would be deducted from future payments.

How can I sell my annuity?

There are many companies (called factoring companies) in the market to buy annuities. Since there are many choices, it’s best to contact various companies and secure a variety of quotes. If you decide to proceed with selling your annuity, here are some of the documents normally required to initiate the process: 1) signed agreement with the factoring company, 2) signed copy of your annuity contract, 3) change of ownership forms as required by the insurance company that issued your annuity.

Once the annuity buyer submits the required paperwork to the insurance company and if it is approved, you will then be able to collect your lump sum payment.

What are the drawbacks/pitfalls?

There are some drawbacks to selling an annuity. For example, selling an annuity can incur a “surrender charge,” which can be as much as 10%. In addition, the seller won’t be able to collect any future payments from the annuity, which can be problematic in terms of retirement planning. Also, there are likely to be tax implications for selling your annuity.