A structured settlement annuity is a financial vehicle or arrangement that a person (claimant) accepts to resolve a tort case such as a personal injury lawsuit. This arrangement provides periodic payments to the individual for a set period of time, instead of a one-time lump-sum payout. In general the arrangement is established by the lawsuit defendant’s insurance company. This arrangement is often called an annuity because it provides a stream of periodic payments just like an annuity, and because an immediate annuity can be purchased to provide the periodic payments. In the United States, these arrangements are usually not taxed; i.e., the periodic payments are not considered gross income to the claimant. Specific laws govern these arrangements at the federal level (see the Internal Revenue Code section 5891(c)(1)) and at the state level.
Structured settlements can be sold by the owner for a lump sum of cash. This is called a settlement factoring transaction. Selling a structured settlement is a difficult decision and is usually only done due to some sort of financial hardship. Unlike the periodic payments that are not taxed, taking a lump-sum buyout of a structured settlement results in taxable income. If you are considering this option, it’s best to consult with a financial planner to see if selling a structured settlement is the best option for you.
To set the price for the sale of a structured settlement, the Time Value of Money must be analyzed (see this FAQ article on future and present value of money). This is a method for estimating the present value of a series of future payments. The Time Value of Money essentially states that a given sum of money available at the present time is worth more than the same amount in the future due to inflation. Here is an example to show how $100 today is worth more than $100 ten years from now. At the current time, $100 can purchase approximately 36 gallons of gasoline in the United States at $2.79/gallon. If gasoline increases at the same rate as it did during the past 10 years, then in 10 years $100 would purchase only 23 gallons of gasoline at $4.29/gallon. So 36 gallons of gas today is arguably more valuable than 23 gallons in the future.
Structured settlement factoring transactions are priced using a discount rate to estimate the present value of the payment stream. A discount rate is an interest rate chosen to estimate the present value of a future cash flow or payment stream. The average discount rate on a structured settlement factoring transaction can range from 8-14% depending upon many factors including the length of the payment stream, periodic payments versus lump sum payments, and how soon the next payment is due to be paid.
More resources:
- Settlement Quotes, LLC provides two online calculators for structured settlements.
- Calculate the discount rate from an offer to buy a structured settlement:
http://www.structuredsettlement-quotes.com/fun/dr/ - Calculate a settlement purchase based on different discount rates:
http://www.structuredsettlement-quotes.com/fun/pv/
- Calculate the discount rate from an offer to buy a structured settlement:
- Suze Orman answers a reader’s question at Oprah.com about selling a structured settlement.
http://www.oprah.com/money/Advice-for-Cashing-Out-a-Structured-Settlement-Suze-Orman-Financial
Article Credits:
Contributed-By: Andrew Cravenho, Chris Lott