Structured settlements provide you with a unique opportunity to take advantage of an investment without risk or tax consequences. Sometimes called a “periodic payment settlement,” these are claim settlements under which some of the proceeds will be payable in deferred installments in lieu of immediate cash. What does that mean to you?
Settlements paid in the form of a single lump sum—especially in catastrophic injury cases—place claimants and their families in the position of managing money that may be intended to provide for a lifetime of medical and income needs. Most people are not experienced in handling large sums of money and, as a result, it is often either spent too quickly or invested, leaving little or nothing to cover the future needs of the seriously injured person.
Structured settlements were developed in order to create a more stable financial footing for claimants. In 1982, the use of structured settlements was encouraged by Congress and special tax code was written. Instead of receiving a single lump sum, guaranteed payments can be made to you over time, through the purchase of an annuity, to better meet your financial needs.
The Internal Revenue Service determined that since the money you receive through a structured settlement is compensation for an injury, you will never pay taxes on any of the payments (principal or interest). There are two primary articles of legislation governing the tax treatment of structured settlements: IRC 104 (a)(2) and IRC 130.
Payments from a structured settlement can be scheduled for any length of time, even for your lifetime, and since you work with a Consultant to determine the payment design, you can remain confident that your future financial needs are addressed. Payment designs can include bi-weekly, monthly, quarterly or annual payments as well as future lump sums. Ongoing payments can be in level amounts or can keep up with inflation by using a Cost of Living Adjustment (COLA).
If a single lump sum payment is taken as compensation for an injury, it is tax-free, but any additional income (called Interest Income) you receive from investing the lump sum will be taxable. The bottom line is that structured settlements provide you with a unique opportunity to take advantage of an investment without risk OR tax consequences.
At the core of the federal tax code's explicit recognition of structured settlements is the concept of constructive receipt: learn more.
Legislative actions and tax codes related to structured settlements: The Periodic Payment Settlement Act of 1982, 468B, 72(u) or 5891.