A structured settlement annuity is fundamentally different from a retail annuity you purchase for retirement savings. It is created by a defendant’s insurance company to settle a lawsuit — the plaintiff receives tax-free periodic payments rather than a taxable lump sum. Here is everything a structured settlement recipient needs to know.
How a Structured Settlement Is Created
When a personal injury, workers compensation, or wrongful death lawsuit is settled, the parties agree on total compensation. Instead of a single taxable lump sum, the defendant’s insurer funds a structured settlement annuity:
- Defendant’s insurer (or the defendant) assigns the settlement obligation to an assignment company (typically a subsidiary of a life insurer)
- Assignment company purchases a structured settlement annuity from a life insurance company
- Life insurer issues the annuity and commits to making payments to the plaintiff
- Plaintiff receives periodic payments on the agreed schedule (monthly, annually, or lump sums at future dates)
The plaintiff does not own the annuity contract. They own the right to receive the payments under the settlement agreement.
Tax Treatment: Why Structured Settlements Are Valuable
Under 26 U.S.C. Section 104(a)(2), damages received from personal physical injury lawsuits are excluded from gross income. This includes:
- The principal (compensatory damages)
- The interest that builds up inside the annuity over time
This is a significant advantage over taking a lump sum and investing it:
- Lump sum invested in a taxable account: interest and gains taxed annually
- Structured settlement: all payments received tax-free, including the interest component
Important exceptions: Punitive damages, emotional distress damages (not from physical injury), and settlements for non-physical claims are generally not tax-free. Tax advice from a qualified attorney is essential before finalizing any settlement.
What the Recipient Can and Cannot Do
| Action | Allowed? |
|---|---|
| Receive payments on schedule | Yes |
| Change payment schedule | No — irrevocable once finalized |
| Sell future payments | Yes, with court approval |
| Transfer payments to heirs | Often yes (depends on settlement agreement) |
| Use as collateral for a loan | No |
| Modify payment amounts | No — fixed by the settlement |
Selling Structured Settlement Payments
If you need a lump sum and want to sell your future payments, you must go through the secondary market:
Process:
- Contact factoring companies (J.G. Wentworth, Peachtree Financial Solutions, Novation Capital)
- Receive competing quotes
- Sign a purchase agreement
- Court hearing required — judge evaluates whether the sale is in your best interest
- If approved, receive lump sum (typically takes 45–90 days total)
Cost of selling: Factoring companies apply a discount rate of 9–18% annually. At a 12% discount rate, you receive approximately 55–65 cents for every dollar of future payments you sell.
Court evaluation criteria:
- Your financial circumstances
- Reason for needing the lump sum
- Whether you have independent legal counsel
- Whether the discount rate is reasonable
- Impact on dependents
Courts have rejected sales when the discount rate was excessive or the seller appeared to not understand what they were giving up.
Structured Settlement vs Retail Annuity: Key Differences
| Feature | Structured settlement annuity | Retail annuity |
|---|---|---|
| Who purchases it | Defendant’s insurer | You (the buyer) |
| Tax treatment | Tax-free (personal injury) | Partially or fully taxable |
| Modifiable? | No | Limited (subject to surrender) |
| Can you sell payments? | Yes, with court approval | Surrender or 1035 exchange |
| State guaranty protection? | Yes — covered by state guaranty association | Yes — same protections |
| Am Best rating applies? | Yes — insurer still must be financially sound | Yes |
| Your ownership of contract | No — you own payment rights only | Yes |
If the Structured Settlement Insurer Fails
If the life insurance company funding your structured settlement becomes insolvent, state guaranty associations provide protection (typically $250,000 in present value of benefits per person per company). The same protections that apply to retail annuities apply here.
To protect large structured settlements, attorneys typically include a requirement that the life insurer meet minimum AM Best rating standards and may structure payments across multiple insurers.
Structured settlement annuities are a specialist product type in the annuities hub. Understand how income streams from annuities work with what are income annuities, and review payout structures in annuity payout options.
The content on Wealthvieu is for informational purposes only and should not be considered financial, tax, or investment advice. Consult a qualified professional before making financial decisions. Full disclaimer · Editorial policy