What is a Structured Settlement?

Although most people don’t know it, personal injury settlements are highly tax-sensitive. Planning one’s settlement using “tax-smart” strategies can substantially increase total net payouts and help resolve cases that might not otherwise settle.

A structured settlement, sometimes called a “structure”, is an agreement in which an injured person agrees to accept a series of payments over time (as opposed to a single lump sum) from a defendant or insurer in return for a release of his or her claim. The name refers to the fact that payments are structured to meet specific needs. Depending on the type of injury, these payments may be tax-free or tax-deferred.

The first payment is typically a check to cover attorney’s fees, liens, and expenses and to establish a cash reserve for the claimant. Future payments on assigned cases are backed by either U.S. Government bonds or annuity contracts from state-regulated life insurance companies*.

A typical structure might look like this:

Who Qualifies for a Structured Settlement?

Structured settlements come in two varieties: tax-free and tax-deferred. Which kind you qualify for depends on the kind of injury you have suffered.

• If you suffered a physical personal injury, your future payments are fully exempt from income tax at both the federal and state level. Under Internal Revenue Code Section 104, payments received on account of personal physical injury or physical sickness are entirely excluded from gross income. This is true whether the money is received as a lump sum or as periodic payments.
• If you suffered a non-physical personal injury, your settlement is fully taxable in the year you receive it. This can create major tax problems if you elect to receive your settlement in a single lump sum. Choosing to receive all your settlement in the same tax year can force you into an artificially high tax bracket, cost you significantly more in taxes than is otherwise necessary, and sharply reduce your net recovery.
  
  A better strategy for many is to spread your settlement payments out over a number of years to hopefully bring them in at a lower tax rate. Deferring taxes in this manner cannot only reduce the immediate tax owed in the year of settlement, but also increase your ultimate return by permitting the deferred amounts to grow tax-free until received.
• If you are a personal injury attorney, you face the same potential “tax bracket leap” as described above for non-physical injury claimants. Allocating a portion of your fee to be paid in future years on a tax-deferred basis potentially reduces taxable income in the year of settlement, increases returns on allocated funds through tax-free growth, can help smooth out the famously uneven revenue flow of your business, and permits more flexible retirement planning.

Structured Settlement Advantages

• Tax-advantaged Income    Payments received on account of personal physical injury or physical sickness are entirely excluded from gross income under Internal Revenue Code Section 104. This is true whether the money is received as a lump sum or as periodic payments. Non-physical injuries may be tax-deferred if properly structured. Money saved on taxes translates directly into higher net income for claimants.
• Financial Security    Future income is guaranteed for certain periods of time and/or for life, depending on need. The annuity contracts used to back structured settlements are issued only by life insurance companies with top-tier credit ratings.
• Spendthrift Protection    Since payments are delivered in measured doses, recipients are protected from undisciplined spending. With proper planning you can ensure that claimants will have money for years to come, safe from financial mistakes and settlement predators.
• Design Flexibility    Future payments can be tailored to meet specific future economic needs, such as wage replacement, medical care, college funding and/or retirement.
• Lifetime Payments    While most people naturally consider the risk of early death, many face the risk of living too long— specifically, outliving the amount of money set aside for their care. Annuity contracts are the only investment vehicles that address longevity risk. By purchasing lifetime benefits, you can shift the risk of living too long from the injured person to the annuity issuer.

By eliminating or reducing the tax on investment income, structured settlements effectively increase the claimant’s purchasing power beyond what is possible through conventional investment of a lump sum. They represents a unique financial advantage when done correctly and in appropriate proportion.