It’s Your Money Use it when You Need it: Do Structured Payment Products Belong in Your Portfolio?

You've probably seen the JG Wentworth commercials offering to buy your structured payment arrangement for cash, but have you ever wondered what happens with that stuff?  Better yet, have you ever wondered if you could get in on the action of buying someone's structured payment out for cash and earning their income stream?  If this has ever been a topic of allure to you, today's going to be a good day.

What is a Structured Payment?

Structured payments can go by a lot of names, we're using this term as a catch all for the post.  This would encompass items like:

  • Annuities
  • Pensions
  • Structured Settlements

The key is that the payment needs to be guaranteed for a certain period of time.  The general concept is really easy, but the complexity of the product in terms of variations can run pretty wild.  Again, if you have a guaranteed amount being paid over a period of time, you're in the club.

Structured Payments


How Does One Make Use of this in His/Her Portfolio?

The simple answer is you buy it.  For those who like the finer mathematical details: you essentially discount the payment stream by a certain rate and give the current owner the Present Value of the payments.  You then receive the payments, which have a Future Value that is greater than the Present Value.   And that is the short and easy answer on how you make money.

The strategy has been used by institutional investors for sometime, and until recently acquiring these products was mostly too complicated for anyone by an institutional investor to buy.

Ok, So is This Structured Payment Thing a Good Idea?

There are a few caveats that are certainly in order when it comes to using this idea as a savings plan that goes into your portfolio.

First, note well that this idea runs in the exotic category.  It's certainly an alternative “investment” by which I mean it's not an SEC regulated product (i.e. there's not a ton of oversight and you'll have a tough time suing anyone who takes you for a ride with one).  However, unlike other alternative investments, there's low risk of principal at play on this one.  So it would be tough for someone to actually take you for much of a ride.

Second, be careful when it comes to stated returns.  These are typically quoted in terms of annual return equivalent for for the cash flow, meaning you take you're purchase price and break it into the number of payments you'll receive and calculate the return needed to achieve the total amount you'll receive.  This is correct, but it's a tad misleading.  Remember, when it comes to assessing savings options, it's wise to run it through a CAGR calculation.  If you do this, the stated return will drop a view 100 basis points.  Still, the rate of return will rival a lot of other fixed income items (it's not uncommon to find roughly 3% CAGR on a 4 year structured payment buyout) and that's certainly better than the 1.48% Bankrate claims I'll currently get on a 5 year CD.

Third, ensure your structured payment is insured.  It won't effect the rate of return much, and it ensures that you get your money back if the original owner dies releasing the payor from their obligation.  This will help you ensure against loss of principal.

So How do I Find Structured Payments to Buy

There's a secondary market, just like there is for stocks, mortgages, and almost all financial tools.  They aggregate the structured payments and then sell them to anyone with the cash willing to buy.   The additional good news is that it's a product that can be accepted by a self-directed IRA, so you can use qualified money to make the purchase.

And, for additional security, the cash flows can be insured (some even come that way with no additional charge) so you don't have to worry about default of the obligor.  Or, since some of these cash flows are annuity or pension, benefits death of the annuitant or pensioner would end payment.  Again, there is insurance against this.

It Works, but Here's Something to Keep in Mind

This is certainly a viability strategy, and a great low risk fixed income play.  But like all other low risk fixed income products, it typically pales in comparison to the use of cash value life insurance as a low risk asset (yeah, who didn't see that coming).  Since this can be used in an IRA (life insurance cannot) it definitely has a place for those loaded with qualified money now sitting in an IRA (it crushes CD's and competes extremely well with annuities).

Also as a funding strategy it certainly beats the rate of return found on a lot of other income producing assets.  There's also the possibility of some interest rate arbitrage.  For example, if you are making a purchase that you could pay in cash or leverage and the interest rate on borrowed funds is below the interest rate on the cash flow, why not borrow the money, purchase the cash flow and make some money on the spread?  It's not perfect and, again, cash value life insurance policy loans work better.  But for those of you who haven't been listening, buying out structured payments is a viable strategy for accomplishing something akin to what life insurance is capable of in a quick pinch.

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