Curious as to what is a structured settlement? A structured settlement is a specialized financial tool often used to resolve personal injury lawsuits. With a structured settlement, the defendant or their insurance company agrees to pay the settlement through periodic payments over time rather than in a single lump sum. This provides long-term financial security for the injured plaintiff. However, structured settlements have specific legal requirements under federal and state laws that regulate their use. Understanding these regulations is important to carry the process, the article will provide a comprehensive view of the legal requirements to start the settlement process.
How Structured Settlements Work
In a typical personal injury case resolved through a lump sum settlement, the plaintiff receives the entire amount upfront after the case concludes. However, receiving such a large amount all at once carries risks. The funds could be depleted too quickly or lost through poor investments.
With a structured settlement, the injured plaintiff receives the settlement through periodic payments over 5, 10, 20 years, or even the duration of their life. These customized payment schedules provide guaranteed income at future dates when funds are likely to be needed, like for college or retirement.
Structured settlements also offer tax advantages. Terms of the structured settlement say that periodic payments are income tax-free when established properly under Section 130 of the Internal Revenue Code. The long-term security and tax benefits make structured settlements an attractive option for injury victims with substantial damages.
The Settlement Process
Acquiring structured settlement payment rights requires additional steps compared to a lump sum settlement. The plaintiff’s attorney first negotiates the total settlement amount and the schedule of future periodic payments. This payment schedule aims to match the plaintiff’s needs and provide long-term financial security.
The structured settlement includes payments for immediate needs as well as future expenses like medical care and lost wages. Once the terms are negotiated, they are written into the settlement documents.
To implement the periodic payments, an annuity contract is purchased from a highly-rated life insurance company. The defendant or their insurer assigns the obligation to make future payments to the annuity company through a qualified assignment. The annuity company assumes liability for the periodic payments in exchange for a lump sum from the defendant used to purchase the annuity.
Why These Legal Requirements Exist
Structured settlements involve long-term financial arrangements impacting vulnerable, injured parties. State and federal laws establish legal requirements to protect structured settlement recipients and regulate industry practices.
Every state has enacted some version of a structured settlement protection act. These laws require clear disclosures when transfers of structured settlement payments are proposed. They also prohibit certain types of transfers to prevent settlement recipients from being taken advantage of.
On the federal level, the Internal Revenue Code outlines requirements for structured settlements to maintain favorable tax treatment. Courts also play a role in approving structured settlements, especially those involving minors and incompetent recipients. Let’s explore the key legal requirements in more detail.
Federal Tax Considerations
For injured plaintiffs, one of the main benefits of a structured settlement is the tax-free status of the periodic payments. This favorable tax treatment is available under Section 130 of the Internal Revenue Code. However, for the payments to be income tax-free, several conditions must be met:
- The periodic payments must be for damages on account of personal physical injuries or physical sickness.
- The payments must be received as compensation for these injuries or sicknesses.
- The structured settlement must be established through a properly qualified assignment.
As long as the settlement meets Section 130 requirements, the periodic payments are not considered taxable income to the recipient. The qualified assignment of the liability to make payments is also excluded from the defendant’s gross income.
Compliance with the Internal Revenue Code is essential for structured settlements to achieve their intended tax benefits. Significant tax liabilities would result if the requirements are not satisfied.
Court Approval Requirements
If the structured settlement involves a minor or a plaintiff who is legally incompetent, proposing to acquire a structured settlement usually requires court approval. The proposed structured settlement terms must be presented to the court. This provides an important additional layer of protection for vulnerable structured settlement recipients.
The court will review the payment amounts, schedule, duration, and other settlement terms. Key factors considered in the court’s review include:
- The best interests of the minor or incompetent plaintiff – The settlement must adequately provide for their current and future financial needs.
- Recommendations of parents, guardians, or other representatives – The court will consider input from adults responsible for the plaintiff in reviewing the settlement.
- Need for conservatorship or trust – For significant settlements, the court may require establishing a conservatorship or trust to manage the funds for minors or legally incompetent plaintiffs.
If the structured settlement meets court approval, the judge will issue a final order authorizing the settlement terms. This court order is a legally binding document, and the structured settlement must adhere to its provisions.
Requirements for Qualified Assignments
To receive tax-free treatment, structured settlements must be assigned to an annuity company through a qualified assignment under Section 130. A qualified assignment meets IRS requirements and transfers the liability to make periodic payments from the defendant to the annuity company.
Specifically, a qualified assignment agreement must satisfy these key conditions:
- The defendant assigns the liability to make periodic payments to the annuity company.
- The assignment is made to fund a structured settlement for physical injury or sickness damages.
- The annuity company and defendant are unrelated parties.
- The injured plaintiff can’t sell, assign, or pledge the rights to receive payments.
The annuity company accepts a lump sum payment from the defendant to assume approval of a transfer and responsibility for the future periodic payments owed to the plaintiff. The qualified assignment releases the defendant from this liability.
Properly qualified assignments that adhere to the Internal Revenue Code are critical for structured settlements to achieve their intended tax advantages.
Restrictions on Transferring Payment Rights
One purpose of structured settlements is to provide long-term benefits that can’t be depleted or lost. To protect this goal, laws strictly limit the ability of structured settlement recipients to assign or redirect their future payments.
Most structured settlement protection acts require court approval for any transfer, sale, or assignment of payment rights. The injured plaintiff must demonstrate that the transfer is in their best interest and follows applicable laws.
Exceptions are made for certain types of transfers. For example, payment rights can be transferred under a divorce court order or child support order without prior court approval in some states. But in most cases, recipients can’t redirect structured settlement payments without a court order.
These restrictions aim to prevent settlement recipients from being pressured into unwise agreements transferring their rights. They help ensure the long-term security structured settlements are designed to provide.
Disclosure Requirements for Transfers
When a structured settlement recipient does seek to transfer their payment rights, structured settlement protection acts impose disclosure requirements on the transferee. These important disclosures must be made in a specified number of days before the transfer agreement is signed.
Required disclosures include:
- The amounts and due dates of payments being transferred.
- The lump sum is being paid in exchange for the transferred payments.
- The discount rate is used to determine the lump sum amount.
- An itemization of any applicable fees and expenses.
- The effective annual interest rate is based on the amount being paid.
- A statement that the payee has a right to cancel the transfer agreement within a certain number of days.
- Notice of the payee’s right to seek independent professional advice.
- Notice of the payee’s right to solicit further bids from other potential buyers.
These disclosures ensure the settlement recipient understands the terms and implications before signing away rights. Standardized disclosure requirements protect structured settlement payees across different states.
Consequences for Non-Compliance
Failure to comply with structured settlement regulations can have serious consequences for both plaintiffs and defendants. Here are some potential penalties:
- Tax liability – If Section 130 requirements aren’t met, the IRS can deem the payments taxable income. This eliminates a major benefit of structured settlements.
- Finality issues – If a qualified assignment is defective, the defendant may remain liable for payments. This exposes them to long-term risks and obligations they aim to avoid through the settlement.
- Loss of licenses – Violating state-structured settlement protection acts can result in fines or the loss or suspension of licenses for insurance companies and brokers.
- Civil liability – Payees can sue if deceived into signing an agreement transferring payment rights without proper disclosures.
- Agreement invalidation – Courts can void transfer agreements that don’t comply with statutory requirements.
Clearly, strict adherence to structured settlement regulations is critical for both plaintiffs and defendants. Consulting knowledgeable legal counsel provides assurance that agreements satisfy all applicable laws.
Best Practices for Compliance
Here are some best practices that structured settlement brokers, insurance companies and other parties should follow to ensure full legal compliance:
- Closely adhere to all provisions of state-structured settlement protection acts.
- Provide required disclosures to the payee in a timely manner.
- Encourage payees to seek independent professional advice before any transfer.
- Maintain clear records documenting disclosure requirements were satisfied.
- Develop strong internal processes and training on legal requirements.
- Consult legal counsel when unsure if an agreement satisfies regulations.
- Carefully comply with the Internal Revenue Code to preserve tax benefits.
- Stay updated on any changes to statutes impacting structured settlements.
Following these practices demonstrates a commitment to ethical conduct and protecting structured settlement recipients. It also minimizes compliance risks that could cause serious problems down the road.
The Importance of Legal Compliance
Structured settlements provide valuable benefits but also have complex regulations governing their use. Full legal compliance is essential to protect the interests of all parties involved.
Understanding requirements like court approval, qualified assignments, and payment transfer restrictions allows structured settlements to be established correctly. Adhering to disclosure rules prevents settlement recipients from being misled. Satisfying the tax code preserves the tax advantages structured settlements are intended to offer.
By working closely with legal counsel, structured settlement brokers, insurance companies, and other parties, you can ensure agreements adhere to all federal and state legal requirements. This diligence in compliance allows structured settlements to safely deliver the long-term financial security they uniquely provide.
Bara is a seasoned expert in the structured settlement and annuity field, with a successful career in structured settlement factoring. Her experience spans prominent companies such as J.G. Wentworth, Peachtree Settlement Funding, and Liberty Settlement Funding, where she managed substantial marketing campaigns. Constantly updating her knowledge, Bara is committed to providing exceptional experiences and maintaining her position as a trusted professional in the industry.