Example of How Structured Settlements Save Money in Taxes vs. Regular Annuities

Let's compare the tax implications of a structured settlement as part of a personal injury claim with those of purchasing an annuity without the tax benefits (i.e. outside of the personal injury litigation context).

Structured Settlement Example

Imagine a personal injury claimant receives a settlement of $500,000. Instead of taking a lump sum, they opt for a structured settlement annuity that provides $25,000 per year for 20 years. Under Revenue Ruling 79-220, these periodic payments are excludable from gross income, meaning they are not subject to federal income tax. This results in significant tax savings over time.

Annuity Purchase Without Tax Benefits

Now, consider the same claimant decides to take the $500,000 lump sum and purchase an annuity independently. They invest the lump sum in a non-qualified annuity, which is funded with after-tax dollars. The annuity provides $25,000 per year for 20 years. However, in this case, the interest portion of each payment is taxable as ordinary income.

Tax Savings Comparison

1. Structured Settlement: The $25,000 annual payments are tax-free, so the claimant keeps the entire amount each year.

2. Annuity Purchase: The $25,000 annual payments are subject to income tax. Assuming a 25% tax rate, the claimant would pay $6,250 in taxes each year, leaving them with $18,750.

Long-Term Impact

Over 20 years, the structured settlement would result in $500,000 in tax-free income, while the annuity purchase would result in $125,000 in taxes, leaving the claimant with $375,000 after taxes.

Conclusion

By opting for a structured settlement, the claimant can save $125,000 in taxes over 20 years compared to purchasing an annuity independently. This example highlights the significant tax advantages of structured settlements, making them a financially beneficial option for many claimants.