Investing in structured settlements within a self-directed IRA can provide diversification to your... [+]
Structured settlements arise from legal settlements where the amount of damages is paid to the recipient as an annuity over a period of years. This might result from a settlement in an accident case where the recipient has been injured or permanently disabled. The other party’s insurance company has agreed to make the payments to the injured party.
Each structured settlement is different. Payments might be a set amount over a period of years, in other cases, the payments might be timed based on the unique needs of the recipient. For example, it might be determined that an expensive piece of equipment used in their care might need to be replaced at specific intervals.
Structured settlements can also occur when a lottery winner chooses to take their winnings as an annuity initially, then changes their mind and wants to convert the balance of their annuity to a lump-sum at a later date.
Structured settlements can be purchased by investors at a discount to the full amount of the payout. The recipients of the structured settlements receive the discounted lump-sum now, the investor’s return is based on receiving the full amount of the annuitized settlement payments in exchange for their upfront investment.
Structured settlements are often purchased by a number of companies who specialize in buying these payment streams from the individuals receiving the payments. They then turn around and sell these payment streams to investors.
Structured settlements in a self-directed IRA
Investing in structured settlements within a self-directed IRA can provide diversification to your retirement accounts. They offer a stream of payments that often has virtually no risk in that the structured settlement payments are made by an insurance company.
Unlike investing in bonds directly, or in bond mutual funds and ETFs, there is no interest rate risk in this stream of payments. The payments will continue per the agreement regardless of the direction of interest rates.
The returns are often attractive in today’s low-interest rate environment. This is due in part to the trade-off investors in structured settlements have to make—that trade-off being higher returns than some other fixed-income vehicles, but in turn giving up a degree of liquidity in that there is not an active secondary market for structured settlements.
Like any other investment held inside an IRA, any taxable income or gains remain tax-deferred (or tax-free in the case of a Roth account) until the money is withdrawn from the account in retirement.
An annuity for your own retirement
Structured settlement annuities often offer attractive rates compared with many conventional annuities that you might purchase directly from an insurer. Each structured settlement annuity is a bit different in terms of the payment structure but buying one or more for your IRA can allow you to set up a high-yielding payment stream that is aligned with your own retirement goals.
What to know when investing in structured settlements with an IRA
When investing in a structured settlement annuity within a self-directed IRA, it’s important to ensure the funds used to purchase the structured settlement come directly from the IRA. Additionally, all annuity payments must be deposited directly into your IRA account. Just like with any type of investment you might make within an IRA, all aspects of making the investment and any returns from the investment must all be handled within the IRA structure.
You will also want to obtain a court order assigning the future stream of payments to your self-directed IRA account as documentation, as well as an amortization schedule outlining the timing of all principal and interest payments.
In order to minimize your default risk, it's important to ensure that the insurance company behind the annuity payments is highly rated and financially sound. Most insurance companies behind these structured settlement annuities are, but you should always perform your own due diligence.
Be sure that your IRA custodian understands the administrative ins and outs of investing in structured settlements within an IRA before you move ahead. This will save you a lot of potential headaches and possible adverse tax consequences down the road.
STRATA Trust is a self-directed IRA custodian, specialized in holding alternative assets within IRAs.
