Is a Structured Settlement an Annuity?
Structured settlements and annuities share a unique connection.
While most structured settlements are annuities, not all annuities are structured settlements.
Learning how structured settlements work is essential to understanding their link to annuities.
What Are Structured Settlements?
Structured settlements result from legal cases, usually personal injury or wrongful death cases.
A plaintiff (the person wronged) who receives money from the defendant (the person or company accused of wrongdoing) can choose to receive compensation via a single lump sum or a structured settlement.
A structured settlement disperses money from a lawsuit gradually over time to act as a safety net and provide long-term financial security to the injured party.
The concept is simple: Someone who receives a huge windfall of cash may run through the money quickly, leaving them dependent on government assistance. But with a structured settlement, the payments are stretched over a longer period.
Settlement payments can be designed to provide money for medical care and other needs. Cost of living adjustments can be factored in as well.
Structured settlements are funded by annuities and all structured settlement brokers are regulated by state insurance commissions. Structured settlement consultants must also comply with at least seven sections of the U.S. tax code.
Structured settlements most often take the form of a fixed annuity. Lawyers for the defendant and the plaintiff work with a trained consultant to flush out details of the settlement, including the size and frequency of payments.
Instead of paying you directly, the defendant sends the settlement money to a life insurance company’s subsidiary, called an assignment company.
The assignment company then buys the annuity from its parent insurance company. The assignment company holds the policy and pays you every month, every quarter or every year — depending on the terms of your contract.
Annuities are customizable contracts that offer timed payouts, guarantees on principal and protection from market fluctuations.
To encourage the use of structured settlements, the Periodic Payment Settlement Act of 1982 made annuity payouts from a structured settlement tax-free. This means you won’t pay any federal, state or local income tax on payments. Interest and dividend taxes don’t apply either.
What Are Annuities?
Annuities can be used in situations other than structured settlements.
Someone who hits the lottery or wins big at a casino may choose to receive their payout through an annuity instead of as a single lump sum.
Like the plaintiff in a personal injury case, lottery and casino winners who opt for periodic payments often do so to ensure the influx of cash lasts for many years.
Annuities can also be purchased by individuals who want to guarantee a steady stream of income for retirement or other purposes.
In this situation, the buyer uses their own money to fund the annuity and can customize the payout and other details to meet their financial needs.
This is why not all annuities are structured settlements. Annuities can be used for other purposes, too.
Why are you selling your annuity or structured settlement payment(s)?
Select all that apply
Who owns the annuity or structured settlement?
Differences Between Annuities and Structured Settlements
Perhaps the biggest difference between structured settlements and annuities is the process of selling them.
If you purchased an annuity with your own money, you may want to cash out early. In most cases, you’ll owe fees and penalties for doing so.
You’ll also face a 10 percent tax penalty if you withdraw money from a retirement annuity before the age of 59 1/2.
Selling structured settlement payments is a different story.
Because structured settlements are meant to earmark money for an injured party’s future, strict state and federal laws govern the sale of payments to third parties known as factoring companies.
Factoring companies purchase future structured settlement payments in exchange for cash now.
To sell a structured settlement, you’ll need to appear before a judge and make a valid case for why you need immediate access to your settlement money. You may be required to have a lawyer present at the hearing.
Selling traditional annuity payments, in contrast, isn’t a legal process.
Differences Between Structured Settlements and Annuities
- Structured settlements are awarded to plaintiffs in court cases. Annuities can be purchased by individuals.
- Annuity sales don’t require court approval if you purchased or inherited the annuity.
- It’s often faster to sell annuity payments than structured settlement payments.
- You may be able to withdraw a small portion of your retirement annuity penalty-free. Structured settlement contracts offer little if any flexibility once finalized.
- The sale of personal injury structured settlement payments is not taxable. However, selling other annuity contracts comes with tax consequences.
You won’t receive the full value of your structured settlement when you sell payments.
Each factoring company applies a discount rate that reduces the amount of cash you receive. Discount rates can range from 9 percent to 18 percent and higher.
An effective discount rate includes this amount plus other costs, such as legal and court fees, commissions to brokers and miscellaneous processing fees.
Because selling structured settlement payments is a legal process, it usually takes longer than selling other annuity payments.
Taxation is also different for selling structured settlement payments versus annuity payments.
The sale of personal injury settlement payments is not taxable. However, if you sell your entire deferred retirement annuity contract, you’ll owe income taxes on all the earnings higher than your original investment.
Examples of Structured Settlements and Annuities
To better illustrate the similarities and differences between structured settlements and annuities, here are a few examples.
These examples are for educational purposes only.
- Wrongful Death Case Involving a Minor
- When Zachary Jones was 12 years old, he was involved in an automobile accident that killed his mother and left Zachary disabled. His father, Jeffery, filed a wrongful death claim in county court on behalf of Zachary and himself. Jeffrey received a lump sum settlement. Because Zachary was a minor, the court approved a structured settlement for Zachary worth $2.5 million to provide him with monthly payments once he turned 18.
- Personal Injury Case
- When Jenna Smith was a child, she was exposed to lead paint in her Baltimore apartment. When she was 18, her family brought a lawsuit against the landlord. The court found Jenna had suffered irreversible brain damage from lead paint exposure. The family won the case and received a $575,000 settlement from the landlord. Due to Jenna’s mental disability, her family chose to create a structured settlement for Jenna to give her roughly $950 a month over the next 35 years. The contract was customized to include a 2 percent payment increase each year.
Examples of Structured Settlements
- Purchase of an Immediate Annuity
- Bob Ayala is 60 years old and decides to purchase an immediate annuity from an insurance company. He gives the insurer a lump sum payment of $200,000. In return, the company converts that money into an ongoing, guaranteed stream of income for the rest of Bob’s life. He’ll start receiving monthly payments from the insurance company within a year.
- Annuity Payments from Lottery Winnings
- Sara Stewart just won a $1.53 billion jackpot in the lottery. She must decide between taking the lump sum or setting up an annuity that would pay out her earnings each year for the next 30 years. Taking the lump sum would give Sara about $553 million after taxes. On the other hand, Sara would receive about $32 million a year from the annuity, or a total of $856 million over 30 years. Sara is worried about spending her winnings too quickly, so she opts for the fixed annuity option funded by the lottery company.
Examples of Annuities
As you can see, annuities and structured settlements may function similarly, but they are used in different situations for different purposes.
Selling structured settlement or annuity payments is a serious decision with many factors to consider. It’s wise to speak with a financial advisor or an attorney to explore your options before selling.
