# How does a structured settlement work in the United States?
In a US structured settlement, damages are paid as fixed future payments funded by an annuity. The mechanism, tax rules, designs and present value.
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A structured settlement pays all or part of a damages award as a schedule of fixed future payments instead of one lump sum: the defendant or its insurer transfers the duty to pay to an assignment company, which buys an annuity from a life insurer to fund every payment on the schedule. In the United States, when the damages compensate a physical injury or physical sickness, each payment arrives free of federal income tax, and the schedule, once signed, cannot be changed by the person receiving it.
This article covers the rules that apply in the United States, mainly federal tax law, with state law where it governs. It is general information, not legal, tax or financial advice.
The arrangement rests on three sections of the Internal Revenue Code. Section 104(a)(2) excludes the damages from the injured person's income, section 130 lets a third party take over the payment obligation without a tax cost, and section 5891 polices the later sale of the payments. Around those sit state statutes on transfers and state guaranty associations that stand behind a failed insurer up to a limit.
$735,000paid over 20 years by a schedule that costs $400,000 to fund in the worked example
5.47%yearly rate built into that schedule, the rate at which its present value equals its cost
19.0%of face value received when $250,000 of distant payments is sold at a 12% discount rate
Worked example with illustrative figures, detailed in the present value and factoring sections. Not market quotes.
## What is a structured settlement?
A structured settlement is an arrangement, made by court judgment or by agreement between the parties, under which damages for a personal injury are paid as periodic payments over time instead of as a single sum. Section 5891 of the Internal Revenue Code defines it in those terms: periodic payments of damages excludable under section 104(a)(2), or of workers' compensation excludable under section 104(a)(1), payable by a party to the case or by a qualified assignee.
A settlement is rarely structured in full. The claimant takes part of the money in cash at closing, to cover attorney's fees, case costs, liens and immediate needs, and the rest funds the schedule. The split between cash and structure is the first decision, and it is made before the settlement agreement is signed, never after.
The vocabulary is worth fixing once. The **payee** is the injured person who receives the payments. The **obligor** is whoever owes them: at first the defendant or its liability insurer, then the assignment company. The **annuity issuer** is the life insurance company whose annuity contract produces the money. The **periodic payments** are the schedule itself, each one set by amount and date.
Structures are used most where the money has to last: a serious injury with long-term care costs, a settlement for a minor that a court must approve, a wrongful death claim that replaces a lost income, or a workers' compensation claim. Periodic payments for claims that are not physical injuries fall outside the tax provisions described here.
## Who are the parties, and how does the money move?
A structured settlement moves money through four parties in a fixed order: the defendant or insurer pays a premium to an assignment company, the assignment company buys an annuity from a life insurer, and the life insurer sends the scheduled payments to the payee. The payee never holds the premium and never owns the annuity.
How a structured settlement is put in placeFrom negotiation to the payment stream, with the usual documents
The schedule is negotiated with the settlementThe parties agree the total value of the settlement, the cash paid at closing and the periodic payments: each amount and each date. A settlement consultant on either side usually obtains annuity quotes so that the cost of the schedule is known.
The settlement agreement records the paymentsThe agreement lists the periodic payments and states that the payee cannot accelerate, defer, increase or decrease them. It also allows the defendant or insurer to assign its payment obligation.
The obligation is assignedUnder a qualified assignment, the defendant or insurer transfers the duty to make the periodic payments to an assignment company and pays it the sum needed to fund them. The assignment company becomes the obligor; the original defendant is usually released.
The assignment company buys the annuityIt purchases an annuity contract from a life insurer, timed and sized to match the schedule, and remains the owner of that contract. Section 130 requires the purchase within 60 days before or after the date of the assignment.
The life insurer pays the payeeThe annuity issuer sends each payment to the payee on its date, on behalf of the assignment company, for as long as the schedule runs.
The order matters for tax reasons. If the claimant were handed the settlement money and then bought an annuity with it, the claimant would simply own an investment, and its earnings would be taxable. The structure works because the claimant only ever has a right to future payments owed by someone else.
That is also why the route cannot be improvised at the last minute. Where the money is first paid into a qualified settlement fund, the fund can stand in the place of the defendant and make the assignment, which gives the parties time to design the schedule; how such a fund is set up and distributes is a separate subject. The first cash payment, with fees and liens taken from it, follows the ordinary disbursement path of any injury settlement.
## What is a qualified assignment under section 130?
A qualified assignment is a transfer of the liability to make periodic payments of personal injury damages that meets the conditions of section 130 of the Internal Revenue Code, so that the company taking over the liability is not taxed on the money it receives to fund it. Without that provision the assignment company would report the premium as income, and the arrangement would not be economical.
Section 130(c) sets the conditions. The assignee must assume the liability from a party to the suit or agreement. The periodic payments must be fixed and determinable as to amount and time. The recipient must not be able to accelerate, defer, increase or decrease them. The assignee's obligation must be no greater than that of the party who assigned it. And the payments must be excludable from the recipient's gross income under section 104(a)(1) or (2), which limits the provision to physical injury, physical sickness and workers' compensation.
The money must also be put into a **qualified funding asset**, defined in section 130(d) as an annuity contract issued by a company licensed to do business as an insurance company under state law, or an obligation of the United States. The asset's payment periods must be reasonably related to the periodic payments, and no payment from it may exceed the periodic payment it funds. The exclusion for the assignee is capped at the cost of those assets.
One sentence of section 130(c) matters to the payee directly. It says that a provision giving the recipient rights as a creditor greater than those of a general creditor does not change when the recipient is treated as receiving the payments. In plain terms, the payee may be given a security interest in the annuity without losing the tax treatment. Without one, the payee is an unsecured creditor of the assignment company, which is a point to raise during negotiation.
## How are structured settlement payments taxed?
Periodic payments of damages for a personal physical injury or physical sickness are excluded from the payee's gross income for federal tax purposes, under section 104(a)(2) of the Internal Revenue Code. The statute covers damages received "whether by suit or agreement and whether as lump sums or as periodic payments," so the exclusion applies to each payment on the schedule as it is received.
The consequence is the main financial argument for a structure. The schedule pays out more than it costs to fund, because the annuity earns a return for 10, 20 or 40 years. When the payments are damages for a physical injury, that built-in growth reaches the payee inside tax-free payments. A lump sum is equally tax-free on the day it is received, but whatever it earns afterwards in a bank or brokerage account is ordinary taxable investment income.
Section 104(a)(2) has limits that shape what can be structured tax-free:
- **Punitive damages** are outside the exclusion, apart from a narrow wrongful death exception in section 104(c) tied to state law as it stood in 1995.
- **Emotional distress** is not treated as a physical injury or physical sickness, although damages up to the amount paid for medical care attributable to emotional distress remain excludable.
- **Workers' compensation** paid for personal injury or sickness is excluded separately, under section 104(a)(1), and can also be structured through a qualified assignment.
A settlement that mixes physical-injury damages with taxable elements needs an allocation in the agreement, and the tax treatment of each part is a question for a tax adviser. State income tax follows its own rules, although most states start from federal definitions of income.
## What payment designs can a structured settlement use?
A structured settlement can combine three building blocks: payments for life, payments for a fixed number of years, and lump sums on set dates. The schedule is designed around what the money is for, and each block has a different answer to the question of what happens if the payee dies.
| Design | What it pays | If the payee dies early |
| --- | --- | --- |
| Life only | A payment every month or year for as long as the payee lives | Payments stop; nothing passes to heirs |
| Period certain | A payment for a fixed term, such as 20 years | Remaining payments go to the named beneficiary |
| Life with period certain | Payments for life, guaranteed for a minimum term | The balance of the guaranteed term goes to the beneficiary |
| Lump sums at set dates | Single larger amounts on chosen dates | Guaranteed lump sums go to the beneficiary |
Two refinements are common. Payments can carry a fixed yearly increase, written into the schedule as a percentage, to offset rising costs; because the increase is fixed in advance, it stays "fixed and determinable." And payments can be deferred, starting years after the settlement, which suits a minor whose schedule begins at 18 or a payee who wants income at retirement.
The design follows the need. Life payments match costs that last as long as the person does, such as care and living expenses. Period-certain payments match a need with an end date, such as replacing income until children are grown. Lump sums match dated events: tuition, an adapted home, equipment replaced every few years. A life-only design buys the highest payment per dollar of premium, since the insurer keeps what is unpaid at death, which is why a guaranteed period is usually added where anyone depends on the payee.
## Lump sum or structure: how do you compare them by present value?
A lump sum and a structure are compared by present value: each future payment is discounted back to today at a chosen yearly rate, and the total is set against the cash that the schedule replaces. The structure is worth more than the cash at any discount rate below the rate built into the schedule, and less at any rate above it.
Take a worked example with illustrative figures. A physical injury claim settles for $900,000. The attorney's contingent fee is one third, $300,000, and case costs are $20,000, leaving $580,000 for the client. The client can take the whole $580,000 in cash, or take $180,000 in cash and let $400,000 fund this schedule: $1,500 a month for 20 years, guaranteed, plus lump sums of $50,000 after 5 years, $75,000 after 10 years, $100,000 after 15 years and $150,000 after 20 years. The monthly payments total $360,000 and the lump sums $375,000.
The table gives the present value of that schedule at five yearly discount rates, with payments counted from the end of the first month.
| Discount rate | Monthly payments | Lump sums | Whole schedule |
| --- | --- | --- | --- |
| 2% | $297,014 | $282,060 | $579,074 |
| 4% | $249,079 | $215,748 | $464,827 |
| 5% | $229,415 | $189,855 | $419,270 |
| 6% | $212,076 | $167,740 | $379,816 |
| 8% | $183,117 | $132,475 | $315,592 |
At 4% the schedule is worth $64,827 more than the $400,000 it replaces; at 6% it is worth $20,184 less. The crossover is the schedule's internal rate, and solving for it is the single most useful calculation a claimant can ask for, because it turns a list of dates and amounts into one number that can be compared with anything else.
The right discount rate is the after-tax return the claimant could realistically earn on the same $400,000, with comparable safety, while drawing the same payments from it. Run that test on the example: an account earning 5% a year after tax, paying out the same schedule, runs dry before the last lump sum and ends $51,129 short; at 6% after tax it meets every payment and ends with $64,732.
Tax moves the comparison. The schedule's rate is earned inside tax-free payments, while the account's return is taxable. For a claimant whose investment income is taxed at an illustrative combined rate of 24%, an account must earn about 7.20% before tax to match the schedule. Present value is not the whole comparison: cash can be redeployed when circumstances change, and the schedule cannot.
## Why are distant payments worth so much less today?
A payment due far in the future is worth much less today than its face amount, and the gap widens quickly as the discount rate rises. This is the mechanism behind every number in a structured settlement, on the way in and on the way out.
What $100,000 due in the future is worth todayPresent value in US dollars, yearly compounding, at 8% and at 4%
Discounted at 8%Discounted at 4%
Illustrative rates. A single $100,000 payment, discounted once a year; no tax, fees or mortality included.
Two readings follow. First, a schedule that looks large in total can cost comparatively little to fund when its biggest payments sit at the far end, which is why the sum of the payments is never the value of the offer. Second, a payee who later sells a distant payment is on the wrong side of the same curve: the buyer discounts at a far higher rate than the insurer used, and the longest-dated payments lose the most.
## What can be changed after the settlement is signed?
Nothing about the amount or timing of the payments can be changed by the payee once a structured settlement is signed. That rigidity is a legal condition, not a habit of the industry: section 130 requires that the periodic payments "cannot be accelerated, deferred, increased, or decreased by the recipient."
It follows that the payee cannot ask the insurer for next year's payments early, cash in the annuity, borrow from it, pause the payments or reshape the schedule when life changes. The payee does not own the annuity contract and has no surrender right over it. What usually can be changed is administrative: the bank account that receives the payments, the mailing address and, in most contracts, the beneficiary named to receive guaranteed payments after death.
The practical defence is in the design. Cash held back at settlement should cover known debts and a reserve for emergencies, and the schedule should carry lump sums at the dates when larger needs can be foreseen. A schedule built with no liquidity is the one most likely to be sold later at a heavy discount.
## Can you sell structured settlement payments, and what does a court have to approve?
Structured settlement payments can be sold to a factoring company for a lump sum, but in practice only with advance court approval under a state structured settlement protection act. Section 5891 of the Internal Revenue Code backs those state statutes with a 40% excise tax, charged to the buyer on its factoring discount, whenever a transfer goes ahead without a qualified order.
A **qualified order** under section 5891 is a final order, issued in advance by a court under the applicable state statute or by the responsible administrative authority, finding that the transfer does not contravene any federal or state statute or any court order, and that it is in the best interest of the payee, taking into account the welfare and support of the payee's dependents. The applicable statute is normally that of the state where the payee is domiciled. The factoring discount is the undiscounted total of the payments acquired, less the amount actually paid for them. Section 5891 also provides that a later sale does not disturb the tax treatment the original settlement had under sections 104 and 130.
State acts add the procedure, and they differ. North Carolina's statute is a fair illustration: the buyer must give the payee a written disclosure statement at least 10 days before the payee is bound, showing the payments being sold, their total, their discounted present value, the gross and net amounts paid, every fee and the discount rate. The court must find, among other things, that the transfer is in the payee's best interest and that the payee received independent professional advice on its legal, tax and financial implications. Notice goes to interested parties at least 30 days before the hearing, and that state caps the discount rate at the prime rate plus five percentage points. Other states set different timings and many set no cap, so the statute of the payee's own state is the one to read.
Return to the worked example. Three years in, the payee offers to sell the two furthest lump sums, $100,000 then due in 12 years and $150,000 due in 17 years. At an illustrative discount rate of 12%, the price is $47,514 for $250,000 of future payments. The factoring discount is $202,486, on which the excise tax without a qualified order would be $80,994. Discounted at 4% instead, the same two payments would be worth $139,466.
## How safe are the payments if the life insurer fails?
The payments are as safe as the life insurer that issued the annuity, backed, if that insurer fails, by the life and health insurance guaranty association of the payee's state up to a statutory limit. A structured settlement is therefore a long-term credit exposure to one or two insurance companies, and it deserves the attention any 30-year credit decision would get.
The chain has two links. The assignment company is the legal obligor, usually a company with no significant assets other than the annuities it owns, which is often an affiliate of the annuity issuer. The annuity issuer is the source of the money and is regulated for solvency by its state insurance department.
If the issuer becomes insolvent, state guaranty associations step in. According to the National Organization of Life and Health Insurance Guaranty Associations, most states set the limit for annuities at $250,000 in present value of annuity benefits, and for a structured settlement annuity the coverage is provided to each payee listed in the contract, typically by the association of the state where the payee resides. Where the present value of an annuity exceeds the limit, coverage is partial, in the proportion of the limit to that present value, and the excess becomes a claim against the estate of the failed insurer. Limits are set by each state's law and are not identical everywhere.
For the schedule in the worked example, valued at $464,827 at a 4% rate, a $250,000 limit would correspond to roughly 54% of each payment under that proportional rule; an association would apply its own statute and valuation basis. Three measures reduce the exposure: choosing an issuer with strong financial strength ratings, splitting a large structure between two unrelated issuers so that each part sits nearer the limit, and asking for the security interest in the annuity that section 130 permits.
## What should you ask before agreeing to a structured settlement?
Before agreeing to a structured settlement, ask for the cost of the annuity, the rate built into the schedule, the identity and strength of the companies behind it, and what happens on death, because none of these can be revisited after signing. The claimant's attorney and a settlement consultant can answer each one.
- **What does the schedule cost to fund?** The premium is the real value of the offer. A schedule described only by the total it pays out cannot be compared with cash.
- **What yearly rate does the schedule carry?** Ask for the internal rate and for the present value at two or three discount rates, as in the table above.
- **Who are the assignment company and the annuity issuer?** Ask for the issuer's current financial strength ratings, whether more than one issuer was quoted, and whether the quotes reflect medical underwriting of the payee's life expectancy.
- **Is every payment guaranteed, or do some depend on survival?** Have each line of the schedule marked as guaranteed or life-contingent, with the beneficiary for the guaranteed part.
- **How much cash is paid at closing, and what does it cover?** Fees, costs and liens come out first; check that an emergency reserve remains.
- **Which part of the settlement is physical-injury damages?** Any taxable element, such as punitive damages, should be identified and kept out of the tax-free schedule.
- **Will the payments affect public benefits?** A payee who receives means-tested benefits needs advice from counsel who handles special needs planning before any schedule is fixed.
- **Will the payee hold a security interest in the annuity?** If not, ask why.
- **What would it cost to sell later?** Knowing the discount in advance is the best argument for building liquidity into the schedule now.