Injured on the Job

Structured settlements provide predictable tax-free periodic annuity payments to parties with physical injuries.

These annuities payments come from insurance carriers that are required by law to invest the settlement funds in low risk securities (typically U.S. Treasury securities). Insurance companies including New York Life, Pacific Life, MetLife, New York Life and The Prudential sell these products. All have an A or higher rating from A.M. Best, a company that provides rating services to insurance companies. As an extra layer of security, state and federal agencies set insurance company solvency standards and regulations to protect investments.

An injured party who selects the structured settlement option (instead of an all-cash settlement) will receive compounded, tax-free payments over a designated time. Because interest accrues tax-free in the annuity account, the ultimate actual payout is larger than if the injured party received all the settlement amount upfront. In contrast, while the all cash payout is not taxable, money earned on the cash payment is immediately taxable (unless invested in tax-free municipal bonds).

For example, a 45-year-old worker suffered a back injury while on the job, requiring surgery and time off work. His claim settles for $500,000 to cover surgery, rehabilitation and lost wages. He can choose to receive a $500,000 upfront all-cash settlement or he can combine an upfront lump sum payout with scheduled tax-free annuity payments. He decides to choose the second option. He collects $200,000 upfront to pay medical costs and rehabilitation. In five years, at age 50, he begins collecting $1,269.39 a month from the annuity for the next 10 years to supplement his income. At age 65, he retires and receives a $300,000 payout. The original $500,000 grew to $652,326.80 while in the annuity, giving the worker an extra $152,326.80 (based on current interest rates).

Negotiating a Structured Settlement

For the permanently injured, going back to work and earning a wage is no longer an option. The settlement funds must be designed so the injured party has adequate finances to pay for ongoing medical and life-long day-to-day living expenses. How and when the injured worker will receive compensation payments is determined during the settlement conference. The worker can elect to receive a portion of the settlement upfront to pay, as in the example above, pressing medical bills or to reconfigure housing to accommodate the physical disability. He or she can then decide to receive lifetime monthly payments or future lump sum payouts.

A structured settlement factors in a person's age, life expectancy, short-term and long-term medical costs, living expenses and family milestones expenses (i.e., children's college education). Often, a life-care plan is created during settlement discussions to help design the structure best suited for the individual's financial needs.

In another example, a 35-year-old worker slips and falls, breaking her wrist and tearing her ACL in one of her knees. The settlement amount is $900,000. She could have received the full amount in cash upon settlement but she decided that a structured settlement could provide better financial security. She received an upfront lump sum of $150,000. At age 40, she began receiving $2,362 a month payments for life (guaranteed for 20 years) and lump sum payments every five years, gradually increasing, until age 65: $50,000 at 40, $55,000 at 45, $60,000 at 50, $65,000 at 55, $70,000 at 60 and $75,000 at age 65. The original $900,000 cash payment turns into an expected payout of $1,885,517.76.

Structured settlements were not always used to resolve physical injury workers' comp claims. Their popularity increased after the Taxpayer Relief Act of 1997 changed the federal tax code to give workers' comp annuity payments a tax-free status.

Inflation Factor

While inflation has been in check for more than a decade, slowly rising interest rates may mean it will increase. To make sure the value of the settlement keeps up with rising costs, one option is to create a stepped structured settlement that involves cost-of-living increases for a fixed period or over the lifetime of the structure.

For example, a 39-year-old construction worker is injured in an accident while driving a company truck. The settlement is for $600,000. He decides to take a lump sum payout of $100,000, and beginning at age 40, he will receive $1,136.7 a month for life with annual increases of 3%. The total expected payout pencils out to $1,314.666.61.

Instead of buying one annuity that will pay one rate over its lifetime, stepped annuities can adjust for inflation to guarantee payments to the injured party that cover long-term cost-of-living increases.

Structured Settlements for Non-Injury Work-Related Claims

The number of on-the-job discrimination charges, according to the U.S. Equal Employment Opportunity Commission (EEOC) stood at 88,778 charges in 2014 with retaliation, race, sex, disability and age discrimination topping the claim allegations.

While settlement funds received for these and other types of non-physical injury cases are taxable, structuring the settlement still has advantages. Payouts are guaranteed and predictable. Interest accrues tax-deferred on the money in the annuity account. As with their tax-free counterparts, these tax-deferred or “non-qualified” settlements can include customized periodic payments to fit the injured party's future financial needs.

To help reduce the tax liability, injured workers can choose to receive payouts in later, retirement years when tax rates are typically lower or in small amounts to keep the total annual payouts below higher tax rates. Regardless of how the payment schedule is devised, income from a non-physical injury structured settlement must be reported on IRS Form 1099 Misc. in the year in which it is received.

Deciding Whether to Use a Structured Settlement

A structured settlement transfers investment risks from the injured party to the annuity provider. By doing so, this eliminates the possibility of the injured party being caught in a volatile investment environment. Why is this important? Plaintiffs choosing upfront cash settlements assume the risks associated with their investments during both stable and unstable economic times. Those requiring lifetime care and support usually do not have the luxury of being able to weather fluctuating incomes, especially when unforeseen medical emergencies are part of life.

In addition, most individuals do not have the experience to make sound financial decisions when it comes to large sums of money. The settlement funds can quickly dissipate through bad investments, friends and family “advice” and careless spending. A structured settlement provides peace of mind to plaintiffs that they will continue to receive their settlement payments regardless of movements in the market.

For defendants, settlements resolve disputes before trial thus avoiding expensive and uncertain litigation outcomes. Payment responsibility moves to the annuity provider.

A structured settlement is not appropriate in every case. If the injured party will be back to work in a short period, the amount of the negotiated settlement is small or the injured party needs all or most of the settlement proceeds immediately, an up-front cash payment may be the best solution. A structured payout plan, however, should be part of the discussion whenever an employment-related settlement is considered.

Patrick Farber is a structured settlements broker with Atlas Settlement Group in California. He works with attorneys throughout the country to create structured settlement annuities for physical and non-physical injury cases. Reach him at 800-734-3910 or [email protected].