What is a Structured Annuity
A structured annuity, also known as a structured settlement or a periodic payment judgment, is an annuity or group of annuities with a very short accumulation phase funded by a lump sum payment similar to a single-pay annuity. It is typically funded by an insurance company or other third party after it is ordered to pay a tort claim in a court of law. Structured annuities are often used to pay worker's compensation claims or other lawsuit winnings through a monthly income guaranteed for life as opposed to a lump sum.
Structured Annuity Overview
Structured annuities were first introduced in the 1970s. Today many consider them advantageous over lump sum payments, particularly for individuals with permanent disabilities, because they guarantee a lifetime income and discourage individuals from irresponsibly spending large amounts of money over a relatively short period of time. The structured annuity concept has the endorsement of many disability advocacy groups.
Starting a Structured Annuity
It is important to remember that the plaintiff awarded damages cannot start a structured annuity. It must be requested that the party ordered to pay the awarded damages (usually an insurance company) do so on their behalf, either by mutual agreement or by court order. Because of the myriad of laws and regulations surrounding structured annuities, one should maintain the counsel of an attorney throughout the structured annuity funding and distribution process.
Distributions for a structured annuity are very flexible. The annuitant can request distribution payments as frequently as weekly, and can also request that payments be made in differing levels in anticipation of future financial needs such as medical equipment replacement or college expenses.
In many cases involving physical injury, the insurance company or other defendant will transfer the liability to an assignment company by paying it a lump sum sufficient to fund the annuity. The assignment company, which is typically affiliated with the life insurance company underwriting the annuity, will then buy the structured annuity on the plaintiff's behalf. By law, in this arrangement a secure asset such as the annuity or government securities must be used to fund the settlement and safeguard its integrity. This is accomplished by a legal device known as “qualified assignment.” Once the qualified assignment is made, the payment schedule cannot be changed in any way.
Qualified assignment often has the dual advantage of immediately satisfying the defendant's legal obligation as well as providing the plaintiff with the assignment company as a creditor rather than the defendant, thus eliminating the risk of the defendant becoming a credit risk to the plaintiff later on.
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Strictly speaking a structured annuity is designed to provide lifetime income for a disabled person in addition to Social Security and without the often undue burden of managing a large nest egg. It can prove to be quite beneficial to anyone who has sustained a permanent disability or who is otherwise unable or unwilling to to manage a large sum of cash on their own. It can also be beneficial if the annuitant is a minor. Indeed many courts will explicitly require a structured annuity in cases involving minors.
Disabled individuals on structured annuities may have part of their distributions diverted to a special needs trust to address inevitable future big-ticket medical expenses. Distributions may also be paid into Medicare set aside arrangements to ensure annuitants remain qualified for Medicare and Medicaid benefits. If needed a special needs trust and a Medicare set aside arrangement should be set up as part of a comprehensive structured annuity program with the assistance of a financial planner who specializes in structured annuities.
According to the Periodic Payment Settlement Act of 1982, if lawsuit winnings stem from physical injury, as is the case with worker's compensation claims, they are not subject to any federal or state income tax. Therefore tax considerations for the annuitant are effectively rendered irrelevant. The distribution phase can begin immediately without regard to age. Should the annuitant die, his or her beneficiaries would receive payments tax-free as well.
If the winnings derive from something other than physical injury, such as for punitive damages, the settlement is taxable and the lump sum is annuitized accordingly. In such a scenario distributions can still begin immediately, but the taxes can be deferred.
The basic alternative to a structured annuity is to request a lump sum payment of one's winnings. While this may be beneficial in some cases, it can cause unintended problems. In addition to the temptation of spending the money irresponsibly and too quickly, the sudden burden of managing a large sum of money can be overwhelming. One needs only look at the riches-to-rags stories of many recent lottery winners to see that large sums of money can be more curse than blessing. In addition, any capital gains on investments made by these lump sum payments are taxable, whereas the amount remains completely tax-free in physical injury cases under the structured annuity construct.
A lump sum could be annuitized by the beneficiary later and separately without the defendant or assignment company as a single-pay annuity, but the tax benefits of the structured settlement would be lost as it would be set up as a non-qualified plan. Indeed it would be illogical to do so if the lawsuit winnings came tax free.
Selling a structured annuity to a third-party company such as J. G. Wentworth is another option. However, bear in mind that any company buying a structured annuity will do so at a discount (after all, someone is paying for their advertisements). In many states such sales require court approval before they can proceed. Even if the sale is successful, many people may find themselves in the exact situation they were in had they taken a lump sum in the first place, complete with the responsibilities and pitfalls associated with it.
Structured annuity advocacy groups such as the National Structured Settlements Trade Association, as well as consumer and disability advocacy groups, have also questioned the business practices of some of these companies.
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