What is a Structured Settlement Annuity?

The structure of an annuity can be beneficial in multiple scenarios. Given the versatility of annuities and how advantageous they can be, the concept of an annuity has been adopted in various environments. This article is going to explain the use of annuities in lawsuits, focusing on structured settlement annuities. 

What is a Structured Settlement Annuity?

A structured settlement pays out money owed from a legal settlement in installments of periodic payments in the form of an annuity. Structured settlement annuities are usually arranged for very large sums of settlement money instead of the recipient being paid one lump sum.

In 1982, Congress passed the Periodic Payment Settlement Tax Act, which effectively established structured settlements. Structured settlements are used to provide long-term financial stability to accident victims and their families. 

The goal behind a structured settlement is to decrease the number of accident victims who receive their award as a lump sum, spend their funds too quickly and end up relying on public assistance. The annuity structure spreads out the payouts and ensures that the victim will have a guaranteed source of income. 

How does a Structured Settlement Annuity Work?

Structured settlements involve four people or entities: the person who has been wronged (the plaintiff), the person or company who caused the harm (the defendant), an experienced consultant (an assignee) and a life insurance company. The following details the process of structured settlements. 

First, the plaintiff must sue the defendant in an effort to receive compensation for the injury, illness or death that the defendant caused. Often, the defendant chooses to give the plaintiff the money through a structured settlement in order to keep the lawsuit from going to trial. If the case were to go to trial and the judge ruled in favor of the plaintiff, the defendant may then be forced to set up a settlement. 

Once it is established that a structured settlement is going to be set up, the plaintiff and the defendant work with a qualified assignee to decide on the terms of the structured settlement contract. During this part of the process, the plaintiff has a lot of say in the specific terms of the contract. The decisions that must be made by the plaintiff are further discussed below.  Once the settlement terms have been decided, the defendant provides money for the assignee to purchase the annuity for the plaintiff. 

The assignee will then purchase the annuity from a life insurance company and set up the annuity contract to match the terms that were determined. There may be an immediate lump sum that is set aside to cover attorney fees. 

Once the annuity has been purchased, the life insurance company pays the plaintiff a series of payouts of a fixed period of time according to the terms that are specified in the annuity contract.

Structured settlements are designed for a specific purpose which is to provide periodic payments over a fixed number of years. However, the plaintiff has the freedom to make certain decisions regarding how the money is distributed and how much money he or she receives yearly. 

Structured settlement payouts can be delayed until retirement or received as an initial lump sum, with subsequent smaller payments over time. Benefits can act as an additional yearly income stream, with payments increasing or decreasing through the agreement term. The plaintiff may opt to receive larger payouts at first and have them decrease over time if that is preferable. The plaintiff can also decide how frequently he or she would like to receive payouts. 

Advantages of a Structured Settlement Annuity 

• The plaintiff receives the guarantee of future income
• Structured settlement payments do not count as income for tax purposes, even when the structured settlement earns interest over time.
• A structured settlement annuity contract often yields more than a lump-sum payout would because of the interest the annuity may earn over time.
• Fluctuations in financial markets do not affect structured settlements. The performance of a structured settlement is not dependent on the financial markets. 
• In the event of the recipient’s premature death, The recipient of the structured settlement annuity can designate an heir in the contract. In the event that the recipient dies prematurely, the designated heir will continue to receive any future guaranteed payments, tax-free.

Disadvantages of a Structured Settlement Annuity

• Once the terms of a settlement contract are finalized, there’s little that can be done to alter them if the recipient realizes they do not suit his or her needs.
• Funds are not immediately accessible in case of an emergency, and you don’t have the opportunity to use the full amount of the settlement for investments that carry higher rates of return.
• Some parts of a settlement can be taxed, such as attorney’s fees and punitive damages. It is important, however, to understand that the payouts are not taxed.

The Bottom Line 

The recipient of a structured settlement annuity should let his or her goals govern the decisions that are made regarding when the payouts will begin, the frequency of the payouts, etc. Recipients of structured settlement annuities should consult with their attorney and a trusted financial advisor for guidance when setting the terms of the contract. 

Special thanks in preparing this summary of “What is a Structured Settlement Annuity?” goes to Bob Carlson, leader of the Retirement Watch advisory service and chairman of the Board of Trustees of Virginia’s Fairfax County Employees’ Retirement System with more than $4 billion in assets.