Key Takeaways
- Structured settlements are often funded by annuities but not all annuities are structured settlements.
- Structured settlements are typically awarded in legal cases to provide victims with regular payments.
- Annuities are insurance contracts bought to ensure a consistent income, usually during retirement.
Is a Structured Settlement an Annuity?
Structured settlements and annuities share a unique connection. Most structured settlements are, in fact, funded through annuity contracts. But while all structured settlements might involve annuities, not all annuities are linked to structured settlements. Annuities serve other purposes, such as providing income security in retirement.
Diving deeper into how annuities and structured settlements work and the purposes of each can shed light on their differences.
What Are Structured Settlements?
Structured settlements tend to result from legal cases such as personal injury or wrongful death lawsuits.
A plaintiff who receives money from a defendant can receive compensation as a single lump sum or through a structured settlement that disperses money gradually over time in the form of set payments. This structure acts as a safety net and provides long-term financial security for the injured party.
Settlement payments may be intended to fund medical care and other needs. Cost of living adjustments can be factored in as well.
State insurance commissions regulate structured settlement brokers. Structured settlement consultants must also comply with at least seven sections of the Internal Revenue Code.
Structured settlements most often take the form of fixed annuities. Lawyers for both parties work with a trained consultant to decide the details of the settlement, including the size and frequency of payments.
Instead of paying you directly, the defendant sends the settlement money to a life insurance company’s subsidiary, called an assignment company.
The assignment company then buys the annuity from its parent insurance company. The assignment company holds the policy and pays you according to the terms of your contract.
To encourage the use of structured settlements, the Periodic Payment Settlement Act of 1982 made annuity payouts from structured settlements tax-free.
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What Are Annuities?
Annuities serve as contracts that promise regular payouts over a set period. Unlike structured settlements, which derive from legal judgments, annuities are broader in scope.
Individuals who want to guarantee a steady stream of income for retirement or other purposes can purchase annuities. The buyer uses their own money to fund the annuity, which eventually converts into a guaranteed stream of payments, typically in retirement.
Annuities are also heavily customizable, giving the buyer the ability to alter things like the payout length as well as adding on various riders and provisions. This flexibility makes annuities attractive to many, including lottery or casino winners who prefer staggered payouts.
Annuities and structured settlements both involve a series of periodic payments, but they are not the same. Annuities are financial contracts purchased from insurance companies, oftentimes, as part of a retirement plan. Structured settlements result from the settlement of a lawsuit.
Thomas J. Brock, CFA®, CPAInvestment, Corporate Finance and Accounting ProfessionalThomas Brock, CFA®, CPA, is a financial professional with over 20 years of experience in investments, corporate finance and accounting. He currently oversees the investment operation for a $4 billion super-regional insurance carrier.
Differences Between Annuities and Structured Settlements
One major difference between annuities and structured settlements is how they are acquired. In general, individuals buy annuities to secure a flow of payments in the future. In contrast, structured settlements arise from legal settlements.
Processes for selling the products also differ significantly.
If you purchased an annuity with your own money, you may eventually decide that you want to cash out early. Doing so usually triggers fees and penalties. You’ll also face a 10% tax penalty for withdrawing money from a retirement annuity before the age of 59 ½.
Selling structured settlement payments is a different story. Given that structured settlements are designed to provide financial support for the future of wronged individuals, strict state and federal laws govern the sale of payments to third parties known as factoring companies. These companies offer immediate cash in exchange for future settlement payments.
To sell a structured settlement, you’ll need to appear before a judge and make a valid case for why you need immediate access to your settlement money. You may be required to have a lawyer present at the hearing.
Selling traditional annuity payments, in contrast, isn’t a legal process. Selling is more straightforward and faster since an annuity is essentially a contract between you and an insurance company.
Taxation is also different when selling structured settlement payments versus annuity payments. Personal injury settlement sales are tax-exempt. However, you’ll owe income taxes when you sell other types of annuity payments.
Read More: Tax Consequences of Selling Annuity Payments
In summary, differences between structured settlements and annuities include:
- Courts award structured settlements to plaintiffs. Individuals can purchase annuities.
- Annuity sales don’t require court approval if you purchased or inherited the annuity.
- It’s often faster to sell annuity payments than structured settlement payments.
- While you may be able to withdraw a small portion of your retirement annuity penalty-free, structured settlements offer little to no flexibility once finalized.
- Selling payments from a personal injury structured settlement is not taxable. Selling other annuity contracts comes with tax consequences.
- You won’t receive the full value of your structured settlement when you sell your payments. Factoring companies apply discount rates, which can vary from 9% to over 18%.
Read More: Structured Settlement FAQs
Examples of Structured Settlements and Annuities
To better illustrate the similarities and differences between structured settlements and annuities, let’s examine a few hypothetical real-world scenarios.
Structured Settlement Examples
Wrongful Death Case Involving a Minor
When Zachary Jones was 12 years old, he was involved in an automobile accident that killed his mother and left him disabled. His father, Jeffery, filed a wrongful death claim in county court on behalf of Zachary and himself. Jeffrey received a lump-sum settlement.
Because Zachary was a minor, the court approved a structured settlement for Zachary worth $2.5 million to provide him with monthly payments once he turned 18.
Personal Injury Case
When Jenna Smith was a child, she was exposed to lead paint in her Baltimore apartment. When she was 18, her family brought a personal injury lawsuit against the landlord. The court found Jenna had suffered irreversible brain damage from lead paint exposure. The family won the case and received a $575,000 settlement from the landlord.
Due to Jenna’s mental disability, her family chose to create a structured settlement for Jenna to give her roughly $950 a month over the next 35 years. The contract was customized to include a 2% payment increase each year.
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Annuity Examples
Purchase of an Immediate Annuity
Bob Ayala is 60 years old and purchases an immediate annuity from an insurance company. He gives the insurer a lump sum payment of $200,000. In return, the company converts that money into an ongoing, guaranteed stream of income for the rest of Bob’s life. He’ll start receiving monthly payments from the insurance company within a year.
Annuity Payments from Lottery Winnings
Sara Stewart just won a $1.53 billion jackpot in the lottery. She must decide between taking the lump sum or setting up an annuity that would pay out her earnings each year for the next 30 years. Taking the lump sum would give Sara about $553 million after taxes. On the other hand, Sara would receive about $32 million a year from the annuity, or $856 million over 30 years.
Sara is worried about spending her winnings too quickly, so she opts for the fixed annuity option funded by the lottery company.
As you can see, annuities and structured settlements may function similarly, but they are used in different situations for different purposes. It’s wise to speak with a financial advisor or an attorney to explore all of your options before choosing or selling either product.
Frequently Asked Questions About Annuities and Structured Settlements
Annuities and structured settlements are not the same. Annuities are purchased through a contract with private insurance companies, while structured settlements are payouts that result from the settlement of a lawsuit.
You buy an annuity with a lump sum or a series of premium payments. Later, typically in retirement, the annuity converts into a stream of guaranteed period payments to provide you with financial security.
A plaintiff may be awarded damages in a lawsuit. These payments often take the form of a structured settlement, where the injured party receives set payments over an agreed-upon amount of time.
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