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The Periodic Payment Settlement Act (PPSA) seeks to prevent plaintiffs from spending large cash settlements quickly and unwisely, rather than using the money for long-term security.
Ensuring Money for the Long Term
The federal government passed the Periodic Payment Settlement Act of 1982 (Public Law 97-473) to protect claimants awarded with cash sums from personal injury and wrongful death lawsuits from quickly depleting their assets and then falling on public assistance to meet their needs.
This is a serious risk, no matter how large the settlement. For example, insurance industry statistics from The Rutter Group show 25 – 30 percent of accident victims use all the funds from their judgments within two months of recovery, and most cash settlements last less than a few years.
To protect claimants from such losses, the PPSA created a powerful tax incentive for the use of structured settlements, a type of annuity that converts a one-time award from a lawsuit into a series of income payments that can last up to a claimant’s entire lifetime. In trial judgment terms, these kinds of settlements are known as periodic payment judgments. Spreading out payments in this way provides long-term, tax-free financial security to victims and their families.
According to the National Structured Settlement Trade Association, more than 500,000 injury victims have settled their accident or wrongful death cases with structured settlements since the PPSA was signed into law.
The Pitfalls of Lump-Sum Settlements
Many recipients are unprepared for the responsibility that comes with receiving a large lump-sum settlement. Managing an investment portfolio can be time-consuming and stressful, especially when you are recovering from a personal injury, illness or loss at the same time. Gains from private investments may also create tax liabilities you do not expect, and bad investments could result in losses that jeopardize your ability to pay for future medical bills and living expenses.
You may face devaluation of your assets due to market changes, and even if you leave your settlement money in a seemingly riskless savings account, its value will still diminish due to inflation. On top of all that, whenever you receive a large cash payout, it is not uncommon for people to come asking you for a loan.
Structured settlements provide long-term financial security. A structured settlement broker can work with you to set up an annuity contract according to your needs, making sure the terms of the structured settlement anticipate the costs of medical, living and family-related expenses over time.
Qualified Versus Unqualified Settlements
Structured settlements are often divided into two categories: qualified for tax exemption and unqualified for tax exemption. Exceptions can exist, however, so consult a financial professional when preparing your state and federal taxes.
The traditional structured settlement for physical injury or sickness claims must meet certain requirements in order to qualify for tax exemption. The settlement amount has to be placed in an annuity, periodic payments must be fixed and determinable as to amount and time of payment, the claimant cannot modify the periodic payments, and those payments must be payable to the recipient.
This type of settlement is used when claims for damages fall outside the usual scope of physical injury, sickness or wrongful death. They are often used for claims involving racial discrimination, sexual harassment, wrongful termination or violation of the Americans with Disabilities Act of 1990 or the Employee Retirement Income and Securities Act of 1974. The tax implications differ among these types of transactions.
The Tax-Free Status of Qualified Structured Settlements
While the PPSA does not mandate the use of structured settlements in any given circumstances, it grants structured settlements a distinct economic advantage over lump-sum payments for the recipients of damage awards. The PPSA amended the tax code to specify the full amount of money given in a structured settlement are damages and, thus, tax-free.
Though lump sum settlements for sickness or personal injury are tax-free as well, the key difference is that a structured settlement can earn interest tax-free. If you invest a lump sum settlement yourself, whatever profit you earn on it is taxable.
However, the PPSA also specifies that for a structured settlement to maintain its tax-free status, payments to an injured person cannot be “accelerated, deferred, increased or decreased by the recipient.” Any changes to the agreed settlement would nullify the contract’s tax advantages. The only way to receive funds ahead of schedule without changing the settlement’s tax-free status is to sell a portion of your payments, in accordance with federal and state laws.
- Hindert, D.; Dehner, J., & Hindert, P. (1986). Structured Settlements and Periodic Payment Judgments. New York: Law Journal Press.
- Mintz, M. (1984, July 24.) Settlement Ends Last Thalidomide Lawsuits in North America. Retrieved from https://www.washingtonpost.com/archive/politics/1984/07/24/settlement-ends-last-thalidomide-lawsuits-in-north-america/9829eff0-c93b-4103-9c05-a234756170d8/?utm_term=.4e9dff51cfe0
- Robinson, W. (2004, October). Structuring Taxable Claims. American Bar Association: Vol 1.1. Retrieved from http://www.americanbar.org/newsletter/publications/law_trends_news_practice_area_e_newsletter_home/structuring.html