What if interest rates rise after I lock in a structured sale?

Hans Goldstein structures installment sales for sellers and works alongside their CPAs. Email hans@goldsteinco.net or call 213-340-2018.

Why can't the rate be reset?

The insurer prices the annuity from its own pricing on the day it is purchased, at closing. That price depends on the length of the deferral, the start date and the payment pattern. Once funded, the payment schedule is set in the contract, and the payments depend on the claims-paying ability of the assignment company and the insurer behind it. The structure is funded only by a fixed annuity. There is no floating or market-linked option.

You also cannot unwind it to buy a better rate. The contract does not allow commutation or early cash-out, because a right to cash out would make the balance taxable now under the constructive receipt rule (Treas. Reg. §1.451-2(a)). Selling the payment rights is a disposition that triggers the deferred gain (IRC §453B(a)). The lock that protects the deferral also locks the rate.

What does a rate change actually cost you?

No one can tell you which way rates will go, and this page does not try. The useful question is how much of your money you want tied to one fixed rate, for how long.

How much does inflation erode a fixed payment?

Illustrative only: a level payment of $10,000 a month, and inflation of 3% a year (an assumption, not a forecast). The table shows what each year's payment buys in today's dollars, computed as $10,000 / 1.03 raised to the number of years.

By year 10 the same check buys about a quarter less. At 20 years, the same arithmetic gives about 55% of today's buying power. Longer and later schedules carry more of this risk.

How do you manage rate and inflation risk before closing?

All of these are chosen before closing and then fixed:

• Shorter terms. Less time locked at one rate and less inflation drag. The trade is less spreading of the gain, so more of it may land in higher brackets.
• Laddered pieces. Split the structured amount into pieces with different terms or start dates, so not everything is priced on one day for one length. Each piece must clear its insurer's minimum, which limits how finely you can split.
• Step-up payments. A schedule that rises over time can offset some inflation, at the cost of smaller early payments.
• Some cash at closing. Cash at closing is taxed in the year of sale at your gross profit ratio, but it is free to invest however you want, including in assets that can respond to rates and inflation.
• Immediate start vs deferred start. An immediate start gets money to you sooner and shortens your exposure. A deferred start (payments beginning years later) fits a seller still working or waiting for lower-income years, but it locks the rate for longer and pushes payments further out where inflation has had more time to work.
• Structure only part of the sale. Many sellers structure the portion they want as steady income and keep the rest liquid. See partial structured sales.

The interest portion of every payment is ordinary income and net investment income, whatever the rate. A higher locked rate means more ordinary income each year, which your CPA should model alongside the gain.

Frequently asked

Q: If rates go up next year, can I get the higher rate? A: No. The rate is locked when the annuity is funded at closing, and the contract cannot be commuted or exchanged. Any new money you invest later earns whatever rates are then.

Q: If rates fall, do my payments drop? A: No. The payment schedule is set in the contract at closing and does not change in either direction.

Q: Are the payments adjusted for inflation? A: No. They are fixed dollar amounts. A step-up schedule chosen before closing can build in increases, but they are set in advance, not tied to an inflation index.

Q: What rate will I get? A: It is set by the insurer's pricing on the day the annuity is purchased and depends on the term, start date and payment pattern. Hans quotes it for your actual structure before you commit.

What should you read or run next?

• What interest rate does it pay, and how is it set?
• What payment schedules can I choose?
• Can I structure only part of my sale?
• Should I just pay the capital gains tax instead?
• How the deal works
• Installment sale calculator
• All structured installment sale questions

Who wrote this?