What is a structured settlement?

A structured settlement is a method of settling a personal injury, workers’ compensation, or non-physical injury claim such as an employement dispute by utilizing periodic payments rather than a traditional lump sum cash payment. The stream of payments is paid to the claimant through a settlement annuity or other funding vehicle purchased by the obligor to fund its obligations under the settlement agreement.


What are the advantages of a structured settlement?

A structured settlement is contractually paid over a period of time and therefore prevents the dissipation of funds by the claimant before the financial needs arising from the injury are met. Further, all payments are income tax-free or tax-deferred to the recipient. This preferential tax treatment for those injured in personal injury and workers’ compensation cases is guaranteed by Internal Revenue Code Sections 104 and 130.


What are the limitations of a structured settlement?

Structured settlement payments are locked in at the time of settlement. While this is desirable to prevent dissipation of the funds by the claimant, it does not account for an emergency cash need from the value of the future payments. Fortunately, Congress amended the tax code in 2002 under Internal Revenue Code section 5891, allowing the claimant to obtain a cash payment of all or a portion of his/her remaining payments through a “Structured Settlement factoring” transaction, as long as the transaction is approved by the applicable state court. Unfortunately, the factoring companies charge a rather high discount on the value of the future payments, making this source of funds expensive.

Another area of concern is the relatively low internal rates of return in relation to the securities market.


When is a structured settlement appropriate?

A structured settlement is most advantageous when the claimant requires or prefers payment of funds over a period of time rather than in a large lump sum, in order to cover continuing medical expenses, replacement of lost or diminished income, or other fixed future income needs. A Structured Settlement is appropriate especially for people who have no experience managing a large lump sum of money, and who require lifetime, tax-free or tax deferred income. It provides them with the security of knowing that the income will always be there.


Why are the payments income tax-free on physical injury and wrongful death?

Payments under a workers’ compensation claim or claims for personal physical injury are excludable from gross income of the recipient under Internal Revenue Code sections 104(a)(1) and (2). If the settlement agreement between the defendant and claimant stipulates a stream of payments funded by the defendant’s purchase of a funding vehicle, the Internal Revenue Service (under Revenue Ruling 79-220) has stated that all of the payments are tax-free to the recipient and his/her estate, including the interest income generated by the investment vehicle that funds the future payments. If the claimant receives a lump sum payment from the defendant and purchased the same investment vehicle, they will be taxed on the interest income portion of the payments.


What is a structured settlement agreement?

It’s standard practice in the structured settlement marketplace that the obligor who enters into a structured settlement agreement transfers its obligations in the agreement to a third-party assignee. The assumption of this obligation is made in a separate contract called an “Assignment Agreement” or “Assignment and Assumption Agreement.” This contract is between the promisor of the underlying structured payments and an “assignee,” which is usually the sister company of the obligor life insurance company, or a wholly owned subsidiary company of the annuity issuer outlined in the underlying settlement agreement. There are two kinds of Assignment Agreements used in settlement of litigation and workers’ compensation cases: qualified and non-qualified.


What is a qualified assignment?

A qualified assignment is used in most structured settlement transactions; the process was authorized under the Periodic Payment of Judgment Act of 1984 (IRC 130). It allows an assignment of the settling defendant’s obligations under a structured settlement agreement to a third-party assignee without taxation of the assignee for the internal buildup of income in the funding vehicle purchased to fund its assumed obligations. The Act limited the transfer to only those payments that fall under IRC 104(a)(1) and (2), for workers’ compensation benefits, personal physical injuries and sickness.


What is a non-qualified assignment?

A non-qualified assignment is one that assumes obligations outlined in a settlement agreement for payments that do not qualify for income tax-free status under IRC 104(a)(1) and (2). This type of assignment may be used for types of damages that are not specifically covered under a qualified assignment, such as emotional distress or other personal injuries that are not physical in nature. It is not available through all life insurers and requires different language than that used under IRS 104 (a)(1) and (2) to protect the payments for tax purposes.


What is the advantage of an assignment?

The advantage of an assignment for the settling defendant is that it removes the defendant/insurer from the risk of insolvency of the life insurer. The advantage for the recipient of the periodic payments is that an assignment replaces a relatively small property and casualty company or self-insured defendant with a large life insurer as its sole obligor under the underlying structured settlement agreement.


Can structured settlement payments flow into a special needs trust?

Under the Omnibus Budget Reconciliation Act of 1993 (OBRA 93), the use of a special needs trust (SNT) prevents the amount paid pursuant to a settlement (either cash or structured) from disqualifying a plaintiff from receiving needs-based benefits such as Supplemental Security Income and Medicaid benefits. Therefore, some settlements may necessitate a SNT, which can be partially funded with a structured settlement. In that case, the SNT is set up prior to the settlement being funded, with the litigants determining the amount of seed monies and periodic payments to be required by the SNT for the future care needs not covered by SSI or Medicaid. The structured settlement transaction will allow the periodic payments to flow tax-free or tax-deferred into the SNT.


What is a Medicare set-aside?

Medicare has frequently been called upon to provide benefits to those injured in lawsuit after the monies paid to the claimant for future medical benefits have been dissipated. Medicare requires consideration that a “set-aside”account be established prior to settlement, wherein the settling defendant will place monies for the benefit of Medicare should the settling claimant be required to use this government benefit in the future. The amount to be set aside is determined case by case, by the parties to the claim and the CMS office.


What is a qualified settlement fund?

A qualified settlement fund (QSF) is a court-ordered safe harbor for funds from one or more settling defendants that allows the defendant to take a complete tax deduction for the entire amount of the settlement monies. The QSF then becomes a new, tax-paying entity that enters into separate settlement agreements (including structured settlement agreements) with those that have claims on the monies. IRC 468B, which authorized the QSF, specifically allows an IRC 130 qualified assignment of the QSF’s obligations to make periodic payments under a structured settlement.


What are the advantages of a qualified settlement fund?

There are advantages for both the settling defendant and the claimant. For the defendant and its carrier, the advantage is a full cash release. A defendant’s carrier does not have an obligation to offer a structured settlement to an injured claimant, but it does have an obligation to obtain a release for its policyholder’s liability. Therefore, no defendant’s carrier should have reason to object to the establishment of a QSF. On the other hand, the administrator of the QSF is usually the representative of the claims to the monies paid into the QSF. This is an advantage to the claimant, as it gives the claimant complete control in the choice of the funding vehicles used in any subsequent Structured Settlement or other investment, as well as breathing room to decide on use of the funds. Another benefit to the claimant is that the QSF grows through investment by the fiduciary of the fund while waiting for all factors to be determined, prior to final distribution of the funds.


I’m the claimant’s attorney. Can I structure my fees?

Yes! In most cases, the claimant’s attorney can utilize the settlement agreement to obtain deferred compensation for fees. Also, the schedules of payments, which are outlined in the settlement agreement, do not need to be tied to the claimant’s stream of payments. In some cases, the attorney can structure the fees even when the client chooses to accept a lump sum cash settlement.