Structured-Settlement Income

How it works

A structured settlement begins when a personal-injury or wrongful-death case settles on terms specifying dates and amounts of future payments rather than a single check. The defendant's liability insurer makes a qualified assignment under IRC section 130 to an assignment company, which formally accepts the payment obligation and buys a matching annuity from a life insurer. That annuity issuer then sends payments directly to the claimant, not back through the defendant or the assignment company.

The claimant has no constructive receipt of the underlying funds and no right to accelerate, defer, increase, or decrease the payments. Those restrictions are not incidental red tape; they are precisely what preserves the federal tax exclusion on the payments. Schedules are built around the specifics of the case: level monthly amounts, lump sums timed to a claimant turning 18 or 65, payments tied to a life, annual step-ups, or combinations of all of these.

The secondary market starts when a factoring company offers a claimant a lump sum in exchange for some or all of the remaining schedule. Every such transfer requires a court order under the relevant state's Structured Settlement Protection Act, with a judge making a best-interest finding. IRC section 5891 backs this up with a 40% excise tax on the factoring discount for any transfer made without a qualifying court order, which is why the court process is not an optional formality.

Once purchased, streams are frequently resold to investors as court-ordered payment rights. The annuity issuer redirects payments to the new owner, and a servicer handles administration. What an investor is actually buying is a packet of paper: the court order, the transfer and assignment agreements, an acknowledgment or stipulation from the annuity issuer, and the details of the underlying annuity policy.

What it pays

For the original claimant, the payment is exactly what the settlement agreement specifies, in nominal dollars, with no discretion on either side to change it. For a secondary-market buyer, the payments are likewise fixed and known in advance; the entire return comes from the discount at which the stream was purchased relative to its face value.

That discount is quoted as an effective yield or discount rate, the rate that equates the purchase price to the scheduled payments. It is driven by the credit quality of the annuity issuer, how far into the future the payments extend, whether any payments are life-contingent, the illiquidity of the asset itself, and the markup taken by the broker arranging the sale.

Life-contingent streams price at wider discounts because the payments stop at the death of the measuring life, with no residual paid to the buyer. Some such streams are sold alongside a mortality-protection wrapper, which costs part of the spread in exchange for smoothing that risk.

Payments do not adjust for inflation unless the original settlement schedule wrote in annual increases, and those increases are set as fixed nominal percentages at the outset, not tied to any published index. Because the cash flows are contractual and dated, the asset behaves like a long-dated fixed-income instrument with no reinvestment of coupons along the way.

Costs and taxes

The original claimant's periodic payments, including the interest element embedded in them, are excluded from federal income tax under IRC section 104(a)(2). That exclusion is what distinguishes a structured settlement from simply investing an equivalent lump sum and paying tax on the earnings each year.

The exclusion does not travel with the payment rights once sold. A secondary-market buyer generally reports the interest element of each payment as ordinary income, with the taxable portion determined by comparing the purchase price to the payments received over time.

For a claimant who sells, the real cost is the factoring discount itself, the gap between the face amount of payments sold and the lump sum actually received, which grows large on long-dated schedules. For a buyer, transaction costs include broker markup, legal review of the court order and chain of title, and ongoing servicing fees where a third party manages the payment redirect.

Most states follow the federal exclusion for the original claimant, while a buyer generally faces ordinary income treatment at both the federal and state level. Purchased streams can be held inside a self-directed IRA if a custodian is willing to hold them, which changes how tax is reported but adds custodial fees and periodic valuation requirements.

Liquidity and time commitment

For the claimant, liquidity is close to zero by design. Anti-assignment language and the tax rules block acceleration outright, and selling any portion of the schedule requires a court proceeding that runs from weeks to months. For a buyer, liquidity is effectively zero as well; there is no exchange for these instruments, and reselling means finding another private buyer and repapering the redirect with the annuity issuer from scratch.

The asset is, in practical terms, a calendar of dates. Money arrives when the schedule says it does, not when the holder happens to need it, and there is no coupon that can be redirected or reinvested in the meantime. Commitments regularly run for decades, and it is the longest-dated payments that tend to be bought at the deepest discounts, compensating for the extended wait.

Once a purchase is made, the ongoing work is light: confirming payments arrive on schedule and keeping the court order, transfer agreement, and issuer acknowledgment on file. Records for these positions typically sit with a broker or servicer rather than a standard brokerage custodian, so the holder carries responsibility for maintaining their own documentation.

How it goes wrong

Title and servicing defects are a recurring failure mode: a stream sold twice, a missing or defective court order, or an annuity issuer that declines to honor the redirect and keeps paying the original payee. Annuity issuer credit risk compounds over a very long horizon, and state guaranty association protection, while real, is capped and legally complicated to apply to an assigned obligation now held by a third-party purchaser.

Life-contingent purchases carry a blunt risk: if the measuring life dies early, payments simply stop, with no residual value paid to the buyer at all. On the claimant side, a common failure is selling far more of the schedule than intended, at a discount rate that only becomes visible once it is computed as an annualized rate rather than presented as a single lump-sum offer.

Buyers sometimes assume the tax-free character of the original payments carries over to them, then discover the interest element is ordinary income in their hands. Brokers can also mark up a stream between the original factoring purchase from the claimant and the retail sale to an investor, so the buyer's realized yield ends up materially lower than the discount the claimant actually absorbed.

Finally, court orders issued under a weaker state protection act, one with thinner best-interest scrutiny, raise the odds that a transfer gets challenged later, clouding title for whoever holds the payment rights at the time.