Annuity settlements, also known as structured settlements or periodic payment settlements, are agreements through which one party agrees to pay another a specific amount of money in the form of regular payments over a predetermined amount of time. This form of settlement is most common in tort cases, specifically personal injury cases and product liability cases in which the plaintiff is likely to need long term financial support. It can also be implemented as a viable settlement in other legal cases, such as those in which the defendant is eager to reach a quick settlement in order to avoid a lengthy and costly trial.
Structured settlements have been encouraged by the federal tax code since 1983, and since then, the laws have evolved significantly to include a complex web of regulations that govern the settlement process. Although the breadth of these issues are beyond the scope of this article, there are some legal and tax considerations that should considered before agreeing to an annuity settlement.
- All annuity settlements must be granted by a court in accordance with applicable law. Once the judgment is handed down, most states require that the first payment arrive to the beneficiary within 45 days.
- In any legal annuity settlement, the scheduled payment for damages must be excludable from gross income under Internal Revenue Code Section 104(a)(2)
- Settlements from workers’ compensation cases are not always exempt from this clause, so you must consult a lawyer to find out if an annuity settlement may work for your workers’ comp case.
- Payments must conform to the specific codes set forth in Internal Revenue Code Section 130(c)(2) paragraphs A and B
- The institution making the payments must be qualified according to the stipulations set forth in Internal Revenue Code Section 130.
- Many annuity settlements are bound by an anti-sale clause which prevents policyholders from selling their settlement, even if they are in dire need of funds.
Advantages and Disadvantages of Annuity Settlements
Though annuity settlements aren’t available to everyone, those who are eligible should consider the notable advantages provided by such a settlement. These include:
- Annuity settlements are guaranteed by contract, which means that the annuity provider absolutely must make the payments on schedule.
- The payments received from an annuity settlement are not subject to income tax, so the recipient can use all of the money he or she receives in each payment.
- Payments from annuity settlements must begin within 45 days of the court confirming the settlement, enabling recipients to rest assured that they will receive their first payment quickly.
- Depending on the term of the contract, annuity settlements may be guaranteed until the death of the recipient, ensuring financial security for the recipient’s entire life.
- Because annuity settlements provide the recipient with regular payments instead of a single lump sum, they help the recipient budget their settlement funds appropriately, reducing the likelihood that they will spend the money too quickly.
Despite the clear advantages of annuity settlements, those eligible for such a settlement should not feel coerced into choosing this form of settlement if they aren’t entirely comfortable. Instead, they should weigh the pros and cons and make an informed decision, as this decision will likely have a lifetime impact. Some disadvantages (or potential disadvantages) that should be considered are:
- Many annuity recipients don’t realize that there may be commissions associated with the setup of the annuity, which can consume a sizeable portion of the principal.
- Anyone who may have a need for a substantial sum of money at once may feel stifled by the payment schedule set forth by an annuity settlement. This would be relevant for anyone who may want to purchase a home, pay for a child’s wedding, or pay off other debts at any time during the settlement period.
- While annuity settlements can theoretically be sold in exchange for a lump sum, most states have enacted laws which restrict these sales, making it difficult for the annuity recipient to receive the maximal payout that they could get from a sale of this nature.
- In cases where the damage that lead to the settlement decreased the victim’s life expectancy, the victim should consider whether he or she will be compensated properly with an annuity settlement whose payments will cease at his death, or whether he needs a settlement that will provide post-mortem benefits for the victim’s beneficiaries.
The best way to make a decision about whether an annuity settlement is right for you is to consider your financial needs in the present and the future, as well as the financial demands of your family. Consider whether you’re likely to need a large sum of money at some point in the future, whether you’ll be able to work again, and your healthcare costs, among other things. Think about your spending habits, and whether you’d be able to manage a lump sum responsibly, or whether an annuity will be able to help you budget your settlement appropriately. And, of course, consult a lawyer and an accountant to ensure that an annuity settlement is in your best legal interests. Taken together, these considerations should help you make a decision that will help you face the future with financial confidence.