Do Structured Settlements Earn Interest?

Structured settlements offer a financial arrangement for individuals receiving compensation from civil lawsuits, particularly those involving personal injuries. This approach clarifies how their financial growth and payment structure operate over time. Understanding the unique mechanics of structured settlements helps recipients manage their long-term financial well-being.

Understanding Structured Settlements

Structured settlements provide a method of compensating individuals by delivering a series of periodic payments over an extended period, rather than a single lump sum. This payment structure is utilized in civil lawsuits, especially for victims of personal injury, medical malpractice, or wrongful death, where ongoing financial support is necessary. The purpose is to ensure long-term financial security for the recipient, particularly when ongoing expenses like medical care or lost income are involved.

This payment approach offers several benefits. It helps prevent the rapid depletion of funds that can occur with large lump-sum payouts, providing a stable and predictable income stream. Payments can be customized to meet specific needs, such as monthly income, annual payments, or larger lump sums at predetermined future intervals to cover anticipated expenses like educational costs or large medical bills. This tailored approach offers a reliable source of funds, relieving the recipient from the burden of managing and investing a large sum of money.

The Mechanism of Financial Growth

Structured settlements do not “earn interest” in the conventional sense, like a savings account or a bond. Instead, the payment stream is funded through the purchase of a single premium annuity contract from a highly-rated life insurance company. An initial lump sum, provided by the defendant or their insurer, is used to acquire this annuity. This annuity contract then guarantees a series of future payments to the claimant according to a pre-determined schedule.

The growth within a structured settlement is built into the terms of this annuity contract. While not explicitly termed “interest,” the future payments received are greater than the initial premium paid for the annuity, reflecting an implicit rate of return. This growth is contractual and guaranteed by the annuity provider, meaning it is not subject to market rate fluctuations or investment performance. The insurance company invests the lump sum into relatively low-risk assets, such as U.S. Treasuries or bonds, to generate the returns necessary to fulfill the guaranteed payment schedule.

The internal rate of return (IRR) on a structured settlement annuity is the constant rate of interest needed to produce the defined future payments from the initial lump sum. This rate is embedded within the annuity’s design, ensuring the total amount received over time exceeds the initial investment. This mechanism provides financial security because the payments are fixed and guaranteed, regardless of market volatility. The specific growth rate is influenced by factors such as prevailing interest rates at the time the annuity is established, the length of the payment schedule, and the chosen payment structure (e.g., level payments, increasing payments).

The defendant or their insurer often transfers the obligation to make these periodic payments to a qualified assignment company. This company then purchases the annuity from a life insurance provider, which assumes the liability to make direct payments to the claimant. This arrangement ensures the claimant receives payments reliably from a financially stable entity, separate from the original defendant. The design of these annuities can be customized, allowing for various payment options such as payments for life, for a set number of years, or including provisions for future lump sums at specific milestones.

Taxation of Structured Settlement Payments

Structured settlements, particularly those arising from personal physical injury or physical sickness, have favorable tax treatment under federal law. Under Internal Revenue Code Section 104, payments received from such settlements are excluded from gross income. This exclusion applies to both the principal amount of the settlement and any growth component built into the annuity payments.

This tax-free status means recipients do not need to report these payments to the IRS and are exempt from federal and state income taxes, as well as taxes on interest, dividends, or capital gains that would otherwise accrue if the funds were invested traditionally.

However, exceptions exist. If a settlement includes punitive damages, those specific amounts are taxable, even in personal injury cases. Structured settlements for non-physical injuries, such as those from employment disputes or emotional distress not directly linked to physical injury, result in taxable payments. In these instances, while the annuity structure might provide tax deferral on growth until payments are received, the payments themselves are subject to ordinary income tax.

The tax benefits for physical injury claims extend to the entire payment stream, providing an advantage over receiving a lump sum and investing it independently, where any investment earnings would be taxable. This ensures the full value of the compensation, including its growth, is available to the recipient without further tax liability.