Structured settlements
Guaranteed incomethat can’t be outlived.
A structured settlement turns some or all of a personal-injury recovery into a stream of periodic payments funded by an annuity. For physical-injury claims, those payments are income-tax-free under IRC §104(a)(2) — growth included.
What it is
A voluntary stream, not a single check.
A structured settlement is a voluntary agreement in which a personal-injury claimant receives some or all of a settlement as periodic payments rather than a single lump sum, typically funded by an annuity issued by a life insurance company. Congress formally encouraged the tool in the Periodic Payment Settlement Act of 1982.
Payments can be tailored to the recipient’s life: paid for a set period or for life, as joint-and-survivor, with future lump sums for anticipated needs, or with cost-of-living step-ups built in at the outset. The schedule is designed once, to match a lifetime.
How it works — IRC §130
The qualified-assignment mechanics.
A structure is built on a §130 “qualified assignment.” Four steps move the obligation from the defendant to a life insurer that pays the recipient directly.
The obligation is created
In the settlement, the defendant or its liability insurer agrees to make future periodic payments to the claimant rather than one lump sum.
A qualified assignment (IRC §130)
The defendant transfers that payment obligation to a qualified assignment company — almost always a single-purpose affiliate of a life insurer. It is a legal novation; the defendant is released.
An annuity is purchased
The assignment company buys a qualified funding asset — a life-insurance annuity (or a U.S. government obligation) — whose payment stream matches the promised schedule exactly.
Payments flow to the recipient
The annuity issuer sends payments directly to the recipient on the agreed schedule. For any life-contingent payments, the recipient is named as the measuring life.
Tax treatment
Tax-free for physical injuries — growth included.
IRC §104(a)(2) excludes from gross income damages received on account of personal physical injuries or physical sickness — whether taken as a lump sum or as periodic payments. The structure’s edge is what happens next.
Under Revenue Ruling 79-220, a recipient excludes the full amount of each periodic payment — not just the discounted value used to buy the annuity. So the internal growth inside a structured-settlement annuity is never taxed. Invest a lump sum instead and the principal is tax-free, but the interest, dividends, and capital gains it earns are fully taxable. That contrast is the single biggest tax difference between the two options.
What stays taxable
- Punitive damages — taxable even in a settlement for physical injuries (IRS Pub. 4345).
- Interest on any settlement, taxed as interest income.
- Emotional-distress damages not attributable to a physical injury.
- Lost-wage components of employment claims, as taxable wages.
Because allocation drives the tax outcome, the settlement agreement should clearly separate physical-injury compensatory damages from taxable components.
Lump sum vs. structured
The same recovery.
A very different lifetime.
Neither option is universally better. A lump sum wins on flexibility and liquidity — paying off debt, covering urgent needs, buying exempt assets. A structure wins on guaranteed lifetime income, tax-free growth, no market risk, and protection from dissipation and creditors.
In practice the answer is rarely all-or-nothing: settlements are commonly split — part taken upfront for immediate needs, part structured for the years that follow.
Market-based options
Some upside, with a floor.
Index-linked structured settlements tie payment growth to a market index (commonly the S&P 500) instead of a fixed rate. They typically pair a cap — a ceiling on credited return — with a floor, often 0%, that protects against losing years. The recipient captures some market upside while being shielded from the downside.
Because they are still funded through a qualified assignment and annuity, index-linked structures keep their §104(a)(2) tax-free treatment for physical-injury claims. The trade-offs are added complexity, returns capped below full market performance, and growth that is less predictable than a fixed structure — so suitability depends on the recipient’s risk tolerance and how essential the funds are.
Who it fits
There is no one-size answer.
A structure makes the strongest case in some situations and not others. The decision turns on a handful of factors a fiduciary weighs together.
Injury severity
The more catastrophic the injury and the longer the care horizon, the stronger the case for guaranteed lifetime income.
Age
Younger recipients with long horizons benefit most from lifetime income and tax-free compounding.
Benefits status
Recipients on Medicaid or SSI usually need payments directed into a special needs trust to preserve eligibility.
Financial circumstances
Where investment experience is limited — or after a traumatic brain injury — guaranteed income reduces exposure to dissipation and market timing.
Dependents
Beneficiary, period-certain, and joint-and-survivor features matter when others rely on the recovery.
Tax allocation
The split between physical-injury, punitive, interest, and wage components drives the tax outcome and should be drafted with care.
Can it change later?
Largely fixed — and that’s the point.
The annuity terms cannot be changed once set. Under IRC §130, payments cannot be accelerated, deferred, increased, or decreased by the recipient — the discipline that protects the recovery from being spent down.
Future payments can be sold on the secondary market to a factoring company — but only at a discount, and only with court approval.
- Every transfer needs court approval under a state Structured Settlement Protection Act — the protection can’t be waived.
- A court may approve only if the sale is in the payee’s best interest, considering their dependents.
- A transfer not approved in advance triggers a 40% federal excise tax under IRC §5891.
- Recipients typically receive only a fraction of face value, because future payments are discounted to present value.
Common questions
Structured settlements, answered.
The questions recipients and attorneys ask most. For the full, sourced set, see our FAQ.
Read the full FAQFor physical personal-injury or physical-sickness claims, structured-settlement periodic payments are excluded from income under IRC §104(a)(2) — including the growth inside the annuity. Punitive damages and interest remain taxable, so how the settlement is allocated matters.
Neither is universally better. A lump sum wins on flexibility and liquidity; a structure wins on guaranteed lifetime income, tax-free growth, and protection from dissipation and creditors. The right answer depends on injury severity, age, benefits status, and financial circumstances — and settlements are often split between the two.
The annuity terms cannot be changed once set — under IRC §130 the payments cannot be accelerated, deferred, increased, or decreased by the recipient. Future payments can be sold on the secondary market to a factoring company, but only with court approval under a state Structured Settlement Protection Act, at a discount, and a non-approved transfer triggers a 40% federal excise tax under IRC §5891.
It depends on the payment design. Life-only payments stop at death. Most structures include a guaranteed or period-certain component, so any remaining guaranteed payments continue to a named beneficiary or the estate — and they stay tax-free for physical-injury claims.
Guarantees are backed by the claims-paying ability of the issuing life insurer. State guaranty associations provide a backstop with caps that vary by state, so for larger settlements the obligation is often spread across multiple highly rated carriers. Recipients should confirm which payments are guaranteed versus life-contingent.
Is a structure right for this recovery?
We’ll weigh lump sum against structure for the actual case — independent, fiduciary, in plain English.