Home > Savings Advice > Minimizing Tax on your Structured Settlement Annuities

Minimizing Tax on your Structured Settlement Annuities

structured settlement annuity taxesStructured Settlements were first introduced by the US National Congress in 1982 and served as a novel method to provide compensation to injury victims. As per the rules of structured settlements, victims are entitled to receive tax free monthly payments to sustain themselves, apart from obtaining a huge sum of money following the accident/ injury.

Reasons behind Creation of Structured Settlements

Previously, physical damage caused to people due to accidents or injuries was compensated by the payment of a substantial sum of money. Often, such a huge sum of money caused problems to the victim and his family. It was difficult for such people to handle a large sum of money all of a sudden. Under these circumstances, it became difficult for the victim to get medical treatment. Some people were also forced to take assistance of other individuals to cope up with the taxes involved with receiving the payment. Thus, in 1982 the Congress came up with the proposal to give money in small amounts to victims of accidents on a regular basis. The primary reasons for receiving payments through structured settlements are injuries, worker compensation and wrongful deaths.

Reasons for Opting for Structured Settlements

The main reasons for which structured settlements should be preferred in case of injury compensations are:

  • They can be invested on your behalf, to get tax-free payments
  • They can help you receive long term payments to support medical treatments
  • They can be used for future investments like purchasing a house, funding education or payment of mortgages.
  • They are completely free of taxes
  • They are very flexible. One can opt to receive monthly payments for 20 years by virtue of structured settlements. Also, people in need of money can receive payments every 72 hours for medical reasons.
  • Monthly payments need not be equal. They can vary in amount.

Components of a Structured Settlement

Depending on the situation, structured settlements come with a number of benefits. They are as follows:

  • Monthly payments after an initial payment of a huge sum of money.
  • Level payments for a lifetime or for a fixed period or both.
  • Level payments accompanied by periodic payment of a large sum of money.

Taxes involved in receiving Structured Settlement Payments

A well planned structured settlement is absolutely income tax free. In fact payments received from such sources are exempt from federal and state laws, the Alternative Minimum Tax (AMT) and taxes on interest and dividends. As per the Internal Revenue Code Section 104(a) (2), compensation received by a person due to some accident, injury or physical ailment, must not be considered a part of the gross annual income of the individual irrespective of the way they receive it (as periodic payments or as a lump sum). All funds received in this manner are completely tax free, regardless of any other income source. At present, you will find it very difficult to locate investment plans that are totally exempt from taxes like structured settlements. Further, you may also be overwhelmed to know the fact that structured settlements are generally offered by the best life insurance companies. As a result, they are not subject to the volatile nature of the financial market. Mary Maybelene from (company name) believes that unlike most investments that work with securities, structured settlements are devoid of any management fees.

Structured settlements may also be tax deferred at times. Tax deferred means that the taxes to be paid on the payments received can be submitted at a later date. Generally, people who receive payments through structural settlements benefit by the generation of extra interest on the deferred taxes. However, it should be remembered that the overall income in such cases will not be tax free in the end.

However, it must be noted that in case of the death of the recipient, the outstanding sum of money (which was supposed to be paid periodically or as a whole) becomes a property of the decedent. As a result, structured settlement payments no longer remain tax free and such may be taxable under the inheritance or the estate tax regulations.

Reasons for No Taxes on Structured Settlements

There are federal tax policies that have been amended several times to make injury compensations free of taxes. Jeremy from Cashfuturepayments.com explains some of them:

  • As per the Revenue Act of 1918, compensation received by anyone on account of injuries was not supposed to be a financial gain. Therefore, it should not be confused with annual or monthly income.
  • In 1928, the IRS claimed that payments received by the decedent from the Mixed Claims Commission of the US and Germany was intended to restore the financial condition of the decedent to a state as was before the death of the victim.
  • In 1983, the President of USA signed a law that was intended to amend the Revenue Act of 1918. As per the new law, any payment received through structured settlements for physical damages would be completely free from any federal tax liability.

At times, you will have a tough time to make insurance advisers believe that structured settlement payments are free of taxes. This is probably because they have dealt with payments of this manner only for a limited number of times and because they believe that structured payments are only applicable in case of injury law suits. If the adviser refuses to believe you, show them the 104(a) or 130(c) of the IRS Code.  To sum up, structured settlement payments are a great way to compensate injury victims, without forcing any taxes on their income.

Image: Freedigitalphotos.net/ddpavumba

About Kim Parr

Kim Parr is a private practice optometrist, freelance writer, and personal financial blogger. You can follow her journey to 20/20 financial vision at Eyes on the Dollar.

Leave a Reply

Your email address will not be published. Required fields are marked *