Area of Law: Personal Injury
Answer # 486
What is a structured settlement?Region: Ontario Answer # 486
Structured settlements are, in essence, guaranteed tax-free annuities. A structured settlement is a way of paying or settling a claim for damages in a lawsuit on a periodic basis over a specified period or for life. Installment payments are usually stretched out over a period of at least five years.
As with any legally required or awarded compensation for a wrongful injury or death, the structured settlement payments are free of tax. However, if the recipient of the payments uses the money to create a gain, such as interest, investment growth or capital gain, that portion is taxable.
Structured settlements are increasingly popular among insurance companies, plaintiffs and defendants. For the recipient, the structured settlement is a guaranteed flow of tax-free and creditor-proof payments that can last for many years or life. For the insurance company or other individual creating the structured settlement, the cash requirement to buy the annuity may be lower than the damages awarded.
A structured settlement can be very flexible in design. Payments can be designed to increase at specific points in time, such as when surgery is needed or large medical payments are expected later in life. The payments can be indexed at a fixed interest rate or linked to the Consumer Price Index to offset inflation. They can also include a series of lump-sum payments.
About half of all significant cases in Canada are settled on the basis of at least part of the settlement being paid with a series of tax-free payments over a fixed term of years or the lifetime of the claimant.
How is a structured settlement created?
The unsuccessful party in a lawsuit (or his or her insurance company) purchases an annuity that exactly fulfils the required payments to the successful party. The annuity is non-commutable, non-assignable and non-transferable. This means no one (including creditors) can change or stop the annuity under any circumstances.
The annuity payments are generally guaranteed for a specific period by the insurance industry, but the original defendant is ultimately responsible for every payment to the claimant. The “guarantee period” may be for the first few decades on a life annuity or for a fixed-term.
The right to structure a settlement must be negotiated during the settlement process and must be part of the documented settlement agreement. The funds to purchase the annuity must pass from the defendant or their agent to the annuity company or its agent. You cannot receive settlement funds first and then purchase a structured settlement annuity yourself after the fact. The annuity must, in fact, be purchased by the defendant or insurance company. During the weeks leading up to settlement, a claimant should make sure his or her lawyer is preserving the right to structure any part of the settlement.
In theory, anyone with a life insurance licence can sell a structured settlement annuity. Without specialized experience, though, a structured settlement may be improperly executed leaving the claimant with significant tax liability. Structured settlement brokers (of which there are about a dozen in Canada) are well known in the legal profession and insurance community. The structured settlement broker will usually prepare all the required documents and help calculate the appropriate structure.
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