Summary: Given the tax-exempt status and safety of structured annuity settlements, is any post-injury financial plan complete without one.
Every year millions of injured Americans confront critically important financial decisions as their personal injury litigation draws to a close. In planning the path forward and beyond their injuries, the stability and security of ongoing, lifelong income from their settlement, judgment or award proceeds becomes absolutely paramount. The money simply needs to last.
Only one post-injury investment option—structured settlement annuities or “structures”—provides a continuing tax exemption for the growth of such benefits. If the injured individual agrees to a lump sum settlement, the tax exemption for lifelong income disappears.
As of 1983, the Periodic Payment Settlements Act (see also IRS regulation Sec. 104(a)(2)) has made all income from a structured settlement annuity over the lifetime of that individual entirely, unequivocally and absolutely tax-free. Contrasted with a lump sum payment in which only the initial payment is tax free and all subsequent earnings are subject to all applicable forms of state and federal taxation, the structured settlement is considered an insurance policy for payments rather than asset to be taxed upon growth. This view, accepted by Congress in that 1983 Act, makes the value of a structure staggering.
For example, if the injured individual deposits the lump sum settlement proceeds in a bank account, any interest earned would be taxed accordingly. If the injured individual invests the money in taxable bonds or stocks, the interest and dividends would also be classified as taxable income. However, with structured settlement annuity payments, neither the growing COLA payments nor the lump sum scheduled payments, nor the payments beyond life expectancy are ever taxable. If the injured party were to decide on an annuity payout after receiving the funds, the tax benefit would be lost because the funds were accepted separately from the settlement. The critical element is that the structure must be accepted as the payout vehicle initially.
The Tremendous Value of Tax-Free Status
The tax-free effect is quite dramatic. Consider an injured individual in the 28% tax bracket with a 2% fee for a traditional, market-based investment portfolio. In addition to having the risk of a significant reduction or entire loss of funds, the individual’s income from the investment when they are successful will face federal taxes that can reduce actual net income by 30% before accounting for state and local taxes that could tack on another 5% reduction. None of these risks or reductions exists with income from a structured settlement.
For an individual in the 10% tax bracket, earning a 4% return would have the equivalent pre-tax return of 4.44%, and a 15% tax bracket would mean an equivalent pre-tax return of 4.7%.
While a peripheral advantage, the tax-free nature of the structure payout means the individual recipient is not required to deal with the timing and accounting issues associated with the need to pay estimated taxes on this money. With a taxable event, the taxes would be the quarterly responsibility of the recipient. An error in dealing with the estimated taxes could create recurring tax problems.
Therefore, structures not only safeguard the injured individual from the volatility of the stock market, they provide continuing income that one can count on down to the penny and to the day. No wild, market-swing surprises. No reductions in income for taxes. No tax filings and accounting homework.
The Gift That Keeps Giving (and Gives in Other Ways)
In addition to the tax-free opportunity, there are other critical reasons to value the structured settlement for the injured individual. First and foremost, the structure enables the individual to couple the tax advantages with the capacity to schedule weekly income and significant payouts for any future expenses like college tuition, wedding costs or retirement needs to the day and to the penny without any worry about market or 401(k) performance. In addition, because structures are considered a policy for payment rather than an asset, such proceeds generally do not affect eligibility for needs-based public assistance programs like AFDC or Medicaid, as lump sums do. Even if the injured individual is not on Medicaid at the time of the injury, eligibility for many programs in-facility care, for example—often requires the absence of any significant assets. As a policy rather than an asset, structure income would be immune from eligibility consideration. Lump sums such as an investment account or a bank account are highly likely to be considered assets that must be eliminated for Medicaid eligibility.
Quite simply, structures may very well be the best way to make sure that the money is peace-of-mind predictable, maximizes other income and benefits and lasts for a lifetime. However, with only 5% of eligible dollars placed in structured settlement annuities, billions in tax exemptions — as well as the opportunity for continuing income security—are squandered every year.
Is a Post-Injury Financial Portfolio “Balanced” Without a Structured Settlement?
While frequently considered an all-or-nothing option, the structured settlement annuity can be used for whatever portion of the settlement, judgment or award that the injured individual chooses. As with all responsible portfolio plans, balance is a critical value.
With a structure, an injured individual can tailor and fund her entire financial future. In addition to continuing payments, what is scheduled today will be there, exactly as needed, for a lifetime of tomorrows. It is possible to establish a college fund, for example, as part of the settlement that would both schedule and quantify tuition—all tax-free.
Given its value, security and stability, is any post-injury financial plan truly “balanced” without taking advantage of structured settlements? As a highly unusual, tax-free, benefits-exempted gift from the U.S. Congress to the nation’s injured individuals, structures should be a critical feature to secure their financial futures.