Calculating Yields in the Secondary Market
Nearly every time we send out an email with new secondary market annuity offers, several inquiries come back with people asking how the return is calculated.
The first resource is one from the vault- a piece we wrote several years ago that is just as accurate today- Which 10% Do you Want?
For more, let’s see an example that everyone can relate to…
Assume a purchase price of $282,951 where monthly income payments of $1500 begin one month from today and continue for 360 months. The effective annual yield is 5% and aggregate cash flow comes to $540,000.
Everyone has seen this similar loan and repayment amortization schedule with a conventional mortgage. With a mortgage you would be the borrower but with a Secondary Market Annuity you are essentially the lender.
The payments outlined above can be a good example of a 30 year mortgage or it could be an excellent income stream from the secondary market. Either would be calculated exactly the same way.
With Secondary Market Annuities many people want to assume that the $282,951 is simply growing at 5% for 30 years, but this is not the case, just as it is not the case with the amortizing mortgage either. Why is this? When money is paid out, the compounding asset balance shrinks.
Every payment on an amortizing mortgage is part interest and part principal, and Secondary Market Annuities are no different- each payment includes an interest earned component, plus a return of principal component. We won’t bore you with an extensive amortization table here outlining 360 payments- if you really want it, just ask and we’ll send it over!
Alternative Way of Looking at Secondary Market Annuities Yields:
There is another simple way to look at it so let’s have another example. Assume you placed $282,951 in a savings account earning 5% effective annual interest (unlikely, I know). If you were to withdraw $1500 per month, after 360 months you would have collected $540,000 and the account would be empty. While you are in fact earning 5% interest, you are not earning interest once the money comes out of the account.
The calculations for these returns are slightly more complicated than a simple (money ‘times’ interest rate ‘times’ time) formula. If that were the case, $282,951 growing at 5% for 30 years would compound to $1,222,886 which isn’t the case here. Money at work in the account earns interest while money in your pocket does not.
Secondary Market Annuities Yield Summary
These examples indicate that not all income deals in the secondary market are appropriate unless the structure meets specific objectives for your retirement plan. Immediate income works for some people and deferred income or future lump sum payments work for others. Which one is best for you? You must answer that question.
There are several ways to capitalize on the secondary market. What we have are above average interest rates and extremely high levels of safety, and a variety of available cash flows. The rate and safety are a compelling proposition in any economy and especially true now. The only thing to determine is what you are seeking, and then match your goal with an available offer.
To maximize the strength of this market, use the right tool for the job- don’t buy an income stream if you have no need for the payments. Instead, let it defer and accrue a few years! Likewise, don’t buy a 10 year deferral annuity if you need money every month.
Please don’t hesitate to call us if there are any specific questions you have about how the secondary market for annuities works, and for assistance selecting the right offers for your specific situation.
Have a great week!
Bryan J. Anderson