When it comes to personal injury, wrongful death, or medical malpractice settlements, structured settlements offer a unique opportunity to ensure long-term financial stability while enjoying significant tax benefits.
What are Structured Settlements?
A structured settlement is an arrangement where injured parties receive their settlement money in a series of periodic payments over several years rather than as a single lump sum. These payments provide a reliable, TAX-FREE income stream.
Structured settlements are commonly used in cases involving:
How Structured Settlements Work
When a plaintiff agrees to a structured settlement, the insurance company of the defendant funds an annuity from a life insurance company. The annuity then makes periodic payments to the plaintiff over a specified period, which can span several years or even a lifetime.
The payment schedule for future payments is tailored to the plaintiff’s unique needs and can include immediate payments, deferred payments, or a combination of both. This flexibility allows for a customized solution that addresses the plaintiff’s long-term financial requirements.
Tax Benefits of Structured Settlements
Structured settlement payments for physical injury cases are completely exempt from federal and state income taxes under IRC Section 104(a)(2). This allows plaintiffs to receive their full compensatory damages tax-free, whether paid as lump sums or periodic payments.
No Income Tax
As per the Periodic Payment Settlement Act and under Internal Revenue Code Section 104(a)(2), compensatory damages received due to personal physical injury or physical sickness are exempt from income tax, whether received as lump sums or periodic payments. This exemption applies to structured settlement payments, ensuring that the plaintiff receives their full settlement amount without ANY tax deductions.
For example, let’s consider the case of John, a construction worker who suffered a severe spinal cord injury due to a workplace accident. John agreed to a structured settlement, receiving $5,000 per month for the next 20 years. Under the tax-exempt status of structured settlements, John will receive the full $5,000 each month without any income tax obligations.
No Constructive Receipt
Structured settlements also help plaintiffs avoid the doctrine of constructive receipt, which states that if a person has control over when they receive their income, they must pay taxes on it immediately. By agreeing to a structured settlement, the plaintiff effectively transfers the control of the settlement funds to the annuity issuer, thus avoiding constructive receipt and the associated tax implications.
Estate Tax Implications
In some cases, the estate of a plaintiff may be subject to estate taxes upon their death. However, with a structured settlement, the remaining annuity payments are generally not included in the plaintiff’s estate, potentially reducing the estate tax burden on their beneficiaries.
Long-Term Financial Security
Structured settlements offer injured parties the opportunity to ensure long-term financial stability through guaranteed income streams and protection from mismanagement or early depletion of funds. The predictable income can help plaintiffs meet their ongoing financial obligations, such as medical expenses, living costs, and family support, without the worry of running out of funds prematurely.
Also, receiving a large sum of money at once can be overwhelming, and many plaintiffs may be tempted to make impulsive purchases or invest in high-risk ventures. Structured settlements, on the other hand, protect plaintiffs from the potential mismanagement or early depletion of their settlement funds by providing a controlled, periodic payment structure.
Potential for Tax-Deferred Growth
In addition to the tax-free nature of structured settlement payments, these arrangements also offer the potential for tax-deferred growth, further enhancing the plaintiff’s long-term financial benefits.
Tax-deferred growth refers to the increase in value of an investment or account without the immediate application of taxes on the growth. In the case of structured settlements, the annuity that funds the periodic payments grows over time, and the plaintiff is not required to pay taxes on this growth until the funds are received as part of their scheduled payments.
How Structured Settlements Facilitate Tax-deferred Growth
When a structured settlement is established, the defendant’s insurance company typically funds an annuity from a life insurance company. The annuity grows over time, and because the plaintiff does not have direct control or access to it, they are not subject to taxes on its growth.
As a result, the claimant’s settlement funds can grow tax-deferred, potentially increasing the total amount they receive over the structured settlement’s life. This tax-deferred growth, combined with the periodic payments’ tax-free nature, can significantly enhance the plaintiff’s long-term financial recovery.
For instance, if a plaintiff agrees to a structured settlement with payments spanning 20 years, the annuity funding those payments will grow tax-deferred during that period. When the plaintiff receives their scheduled payments, they will benefit from both the tax-free income and the tax-deferred growth of the underlying annuity.
Requirements for Tax-Exempt Status
There are requirements that must be met for your future payments to qualify as tax-free:
Structured Settlements Vs. Lump Sum Payouts
While some plaintiffs may be tempted to opt for a lump sum payout, structured settlements offer several advantages that make them a more appealing choice for many.
Risks of Lump Sum Payouts
Receiving a large sum of money at once can be overwhelming and lead to poor financial decisions. Studies have shown that many plaintiffs who receive lump sum payouts deplete their settlement money within a few years due to mismanagement, overspending, or bad investments. Therefore, many regret taking lump sum settlements.
Moreover, lump sum payouts are immediately taxable, which can significantly reduce the net amount received by the plaintiff. In some cases, the sudden influx of money may even push the plaintiff into a higher tax bracket, further increasing their tax liability.
Challenges of Investing Lump Sum Settlements
Some plaintiffs may choose to invest their lump sum settlement in the hopes of achieving higher returns. However, this approach comes with its own set of challenges and risks.
Firstly, achieving a consistent 10% annual return in the stock market is not guaranteed and requires significant investment knowledge and skill. Many individual investors fail to match market returns due to poor timing, emotional decision-making, and lack of diversification.
Secondly, investing a lump sum settlement also involves paying management fees, which can eat into potential returns over time. In contrast, structured settlement annuities do not typically involve any management fees, allowing the plaintiff to receive their full payment amount.
Advantages of Structured Settlements
Structured settlements offer several key advantages over lump sum payouts:
Disadvantages Of Structured Settlements:
While structured settlements offer numerous benefits, it’s essential to consider some limitations and potential drawbacks:
How To Set Up a Structured Settlement?
If you’re considering a structured settlement payment stream for your personal injury, wrongful death, or medical malpractice case, it’s crucial to work with experienced professionals who can guide you through the process.
Conclusion
A structured settlement agreement provides a unique opportunity for plaintiffs in personal injury, wrongful death, and medical malpractice cases to ensure long-term financial stability while enjoying significant tax benefits. By offering a reliable, tax-free income stream, protection from mismanagement, and customizable payment options, structured settlements can help plaintiffs secure their financial future and focus on their physical and emotional recovery.
If you’re considering a structured settlement for your case, consult with your attorney and a structured settlement expert to explore your options and determine the best path forward. With the right guidance and planning, a structured settlement can provide the peace of mind and financial security you need to move forward confidently.
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