STRUCTURED SETTLEMENTS
Information for injured people
This fact sheet has been produced to provide information to injured
people about the tax treatment of structured settlements and
structured orders. The components of a structured settlement and
structured order are outlined below. As structured settlements are
expected to be far more common than structured orders, they are
the primary focus of this fact sheet. See the end of this fact sheet
for details on how to obtain further information about structured
settlements.
Who should consider a structured settlement?
If you have a severe personal injury because of the fault of someone
else, you may be able to make a claim against that person or their insurer
for compensation. A lawyer can advise you whether or not you have
a valid claim.
You may be entitled to receive your compensation in the form of a lump
sum or a structured settlement.
You can arrange to receive your compensation in the form of a structured
settlement only in certain types of cases and only if your compensation is
sufficiently large.
You can only enter into a structured settlement if the lump sum compensation
payment that you would be awarded if your case was decided by a court
would be a tax-free capital payment.
Also note, structured settlements are not available for workers’ compensation
type claims.
What is a structured settlement?
A structured settlement is the result of an agreement between the parties
to a personal injury case. A personal injury case may arise from medical
negligence, sporting accidents, motor vehicle accidents, and public liability
or product liability. The parties to the case will generally be you or your legal
personal representative (for example, a trustee or person with your general
power of attorney), the defendant (who is the person or organisation you
are seeking compensation from), and in most cases the defendant’s insurer.
A structured settlement will enable you to take all or part of your personal
injury compensation in the form of tax-exempt or tax-free periodic
payments, rather than a single immediate lump sum payment. Once
a structured settlement has been arranged you can’t change it or cash
it out for a lump sum. The components of a structured settlement are
outlined in this fact sheet.
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What is a structured order?
A structured order is made by a court, often without the agreement of the
parties. The outcome is similar to a structured settlement, as compensation
will be paid to you in the form of tax-free periodic payments. A structured
order must satisfy the same conditions that structured settlements require
to be tax-free.
When can I get a structured settlement?
You can only arrange a structured settlement before your personal injury
case has settled. It is not possible to arrange a structured settlement after
you have settled your case or if a court has given final judgment for a
lump sum.
Other conditions
You can get a structured settlement if the following conditions are met:
s The compensation or damages are for your personal injury. The claim
for compensation cannot arise out of the death of another person.
s The claim is made by you or your legal personal representative.
s Your claim is based on a wrong done to you or a right that you have
under law (for example, medical negligence, sporting accidents, motor
accidents, public liability and product liability).
s The claim is not a workers’ compensation type claim.
s The settlement is a written agreement.
s Some or all of the compensation or damages is used by the defendant or
their insurer to purchase one or more annuities to be paid to you or your
legal personal representative.
What are the components of a structured settlement?
There can be several components of a structured settlement. These
components must satisfy certain conditions to be eligible for the tax
exemption.
Compulsory component
A structured settlement must include one or more personal injury annuities
that together will provide you with a minimum level of monthly payments
for as long as you live. An annuity is a financial product that is usually
provided by life insurance companies and will provide regular payments
to a person. Personal injury annuities must satisfy certain conditions. For
more information on these conditions refer to the fact sheet Structured
settlements— information for lawyers or speak to your lawyer. The personal
injury annuity component is compulsory for all tax-exempt structured
settlements.
If you have a structured settlement, the defendant or their insurer must
buy you a personal injury annuity that will provide you with tax-free monthly
payments for as long as you live. You cannot buy the annuity yourself.
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These annuity payments must increase each year in line with inflation and
be at least equal to the amount of the basic age pension. You can phone
Centrelink on 13 23 00 to find out the current level of the age pension.
Optional components
Immediate cash component
A structured settlement will often include a cash component that is paid
to the injured person immediately after the settlement has been arranged.
This means that part of your compensation money will be paid to you as
an immediate lump sum that you can use to pay your costs, pay any debts,
purchase equipment, invest and so on. This component is optional, but most
people will need some cash immediately after the settlement of their case.
Other optional components
A structured settlement that includes the compulsory personal injury annuity
providing the minimum necessary periodic payments (the compulsory
component) can also have:
s other personal injury annuities (which have more flexible conditions than
the compulsory minimum annuity), and/or
s personal injury lump sums (which can provide tax-free lump sums at
pre-agreed future dates).
Personal injury lump sums can be combined with a personal injury annuity
or annuities. Under a settlement agreement you can arrange to have a single
lump sum paid at a future date or a series of lump sums at future dates.
Personal injury lump sums could be scheduled to cover future known
expenses—for example, the replacement of a wheelchair every five years.
These dates must be determined at the time of settlement..
A structured settlement will give you certainty that you will continue to
receive a tax-free monthly income for the rest of your life. The amount of
your periodic payments will be guaranteed and won’t vary depending on
what happens in the economy or on the financial markets.
A typical structured settlement
Joe was severely injured. The party responsible for Joe’s injury is insured.
An agreement has been reached resulting in a structured settlement. The
insurance company pays an amount to a life assurance company, which
will ensure that Joe receives the following payments:
s a personal injury annuity providing payments for the remainder of
Joe’s lifetime which is equal to or greater than the basic age pension
(compulsory component)
s an immediate lump sum to pay for debts incurred before the
settlement such as legal fees and alterations to Joe’s house (optional
component), and
s an indexed personal injury lump sum amount every three years to
purchase a new wheelchair or other equipment (optional component).
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How much money is enough for a structured settlement?
The minimum level of the personal injury annuity or annuities is equal to
the basic age pension. Many severely injured people will need substantially
more than this. It is expected that only the most severely injured persons will
have a sufficiently large claim for compensation or damages to be able to
obtain a structured settlement.
A lawyer will help you work out the total compensation money you are likely
to receive and whether this is enough for a structured settlement.
The cost of an annuity providing the minimum level of payments will depend
on how long you are expected to live. Less money will be required to provide
the minimum amount to an older person with a shorter life expectancy than a
young person with a longer life expectancy. The cost will also vary depending
on other factors that affect the cost of annuities, such as interest rates.
How long will I receive payments?
The periodic payments from a structured settlement are designed to provide
you with the maximum amount of compensation money while you are alive.
If you live longer than expected, the payments will continue to be made for
as long as you live. However the periodic payments will stop when you die,
unless you have arranged a guarantee period as outlined below.
When you set up your structured settlement you can arrange to have
your personal injury annuity payments guaranteed for up to 10 years. If
you choose to have a guarantee period of 10 years, for example, this will
mean that if you die within 10 years from the date of settlement then the
remaining payments (that would have been paid if you had lived out the 10
years) can be paid tax-free to your dependants. If your dependants wish to,
they can take the remaining payments as a single lump sum. If the remaining
payments are to be paid to your estate, they must be paid as a lump sum.
If the personal injury annuity commences after the date of the settlement
the guarantee will be a period less than 10 years. It will not be possible to
have a guarantee period if the personal injury annuity is to commence later
than 10 years after the date of settlement. The guarantee period only applies
to personal injury annuities.
How are structured settlement payments taxed?
The personal injury annuity and personal injury lump sum payments that
you receive from a structured settlement are tax-exempt or tax-free.
You can take part of your compensation in the form of an immediate lump
sum. This money will be tax-free at the time that you receive it. But if you
invest that money for future use and receive dividends or interest on that
investment, these earnings will be taxed as income.
If you only receive tax-exempt personal injury annuity and personal injury
lump sum payments you will not be required to lodge a tax return. However
if you have other sources of income or receive interest or dividends, you
may need to lodge a tax return. If you are required to lodge a tax return,
do not include payments made to you under a tax-free structured settlement
in your tax return.
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Who should I talk to about structured settlements?
A financial adviser can look at your whole financial situation and advise you
and your lawyer about the options for receiving your compensation money.
For example, a financial adviser can help you work out how much of your
compensation money should be paid as an immediate lump sum and how
much should be used to pay for the income stream of annuities.
How you design your structured settlement using the money and products
available will be up to you.
If you want to receive your compensation in the form of a structured
settlement you need to start by talking to your lawyer. You need to do this
before your claim for compensation is finalised.
Where can I find out more information?
If you would like more information about structured settlements you can:
s refer to other fact sheets in this series
s download information from the Tax Office website at www.ato.gov.au
s refer to Division 54 of the Income Tax Assessment Act 1997
s refer to the Taxation Laws Amendment (Structured Settlements and
Structured Orders) Act 2002.
For information on the level of the current age pension phone Centrelink
on 13 23 00 or visit the Centrelink website at www.centrelink.gov.au
If you do not speak English and need help from the Tax Office, phone the
Translating and Interpreting Service on 13 14 50.
Other fact sheets in this series
Copies of the following fact sheets can be downloaded from the Tax Office
website at www.ato.gov.au:
Structured settlements—information for life insurance companies
(NAT 8633—6.2003)
Structured settlements—information for defendants and their insurers
(NAT 8632—6.2003)
Structured settlements—information for lawyers (NAT 8630—6.2003)
Structured settlements—information for financial advisers
(NAT 8631—6.2003).
© Commonwealth of Australia 2003
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