By: Patrick Farber | OCTLA’s The Gavel | Fall 2017 Issue
The Federal Reserve has raised short-term interest rates at a quickening pace since the financial crisis and has signaled that more increases are in the works. Plaintiffs considering a structured settlement may be concerned they will miss future higher investment returns on their settlement funds as the result of increasingly higher interest rates if they lock in a structured annuity today.
Fortunately, there are creative solutions so that current structured annuity payments can be adjusted upwards over time to account for market or inflation increases or if claimants know certain life milestones will require additional funds in the future.
Stepped annuities involve increases in structured settlement payments for a fixed period or over the lifetime of the settlement payments. In one case, a 40-year-old teacher was rear-ended in a car crash and suffered a severe back injury that made it impossible for him to return to the classroom. The negotiated settlement between the plaintiff and the defendant’s insurance company was $2 million. A stepped payment plan was created to compensate for loss of earnings throughout the claimant’s life and for inevitable increases in the cost of living.
The structured plan was designed for the claimant to receive monthly payments guaranteed for 20 years, with an initial monthly payment of $3,000. This amount would increase by $1,000 per month every five years (at age 45 and 50) until he reaches age 55. At 55, a life-only annuity would begin, paying him $6,000 a month for the rest of his life.
Instead of buying one annuity that would pay a fixed amount over its lifetime, additional annuities are purchased and are scheduled to begin paying at future dates. In addition, if the claimant knows that a new car, cost for college or some other large expense is in his future, he has the option to arrange for additional payments in certain years to cover these costs.
Tied to S&P 500
A relatively new annuity product from Pacific Life is tied to increases in the stock market. When the S&P 500 Index rises over a 12-month period, payments from a structure with a Pac Life S&P 500 Index-Linked rider are recalculated and can increase by an annual maximum of 5 percent. When the S&P 500 Index has a negative or zero return, however, there is no reduction in the payment amount.
For example, a 35-year-old injured man decided to use this type of annuity in his structured settlement. Payments began at $3,000 per month for life with a 20-year guarantee. Since the annuity contains an S&P 500 Index-Linked rider, monthly income would increase from 1 percent to 5 percent the following year depending on the growth of the index. For example, if the S&P Index grew by 2 percent, the $3,000 monthly payment would also increase by 2 percent the following year to $3,060 per month. If in year three, the S&P Index grew by 4 percent the monthly amount would increase by 4 percent for the next 12 months. If in any given year the S&P Index does not increase or has a negative return, the monthly income is not affected and will remain the same for the next 12 months.
Having an annuity that increases as the S&P 500 Index increases is a way for the claimant to keep payments on par with the returns enjoyed by investors in a rising stock market environment but without the downside risk.
Another option to consider for an injured client is inflation-adjusted annuities. Inflation-adjusted annuities will ensure payments keep up with rising inflation by increasing each year by the selected inflation percent (i.e., 1 percent, 2 percent or 3 percent).
For example, a 24-year-old college student was struck at a crosswalk by a truck. She suffered a broken neck and fractured hip. Due to her extensive injuries she is now a complete quadriplegic. Her case settled for $6.5 million. An annuity plan with an inflation component was set-up for her where she would begin receiving monthly payments of $5,000 for life with a 20-year guarantee. She selected a 2 percent annual increase for the lifetime of the annuity.
In another example, Joe, age 21, was driving a forklift when he lost control of the vehicle. He attempted to jump out of the way of the forklift, but was pinned. His lower extremities were crushed and both legs were amputated after the incident.
His case settled for $5 million. Joe is receiving $3,000 per month guaranteed for 20 years. He will also receive lump sums of $100,000 every five years for the next 30 years.
Factoring in A Structure’s Tax-Free Status
When the structured settlement is derived for a physical injury or workers’ comp claim, the plaintiff receives money from the payout tax-free. It does not matter if the injured party receives all the proceeds immediately or in later years. The tax-free status of payments from the qualified structured settlements for physically injured parties was codified in the Periodic Payment Settlement Act of 1982 (Public Law 97-473).
This means the real return on a structured settlement annuity is similar to a comparable taxable investment. This is particularly true in states such as California where state income taxes are high. Another added advantage: the funds in the annuity compound tax-free.
In the case of the injured college student who was struck in the crosswalk, the internal rate of return is 3.25 percent, which would be equivalent to a taxable rate of 4.5 percent.
For the injured forklift driver, his benefits grow at an internal rate of return of 3.34 percent annually, which would be an equivalent rate of 4.55 percent if taxed.
While structured settlements give injured plaintiffs guaranteed income for 10, 20, 30 years or more, it is up to the plaintiffs legal counsel and structured settlement broker to design an annuity payment plan that will be sufficient for a secure financial future.
During a lifetime, markets will inevitably fluctuate, interest rates will rise and fall and inflation will always be a factor. Including a component within the structure to account for inflation and market fluctuations can provide peace of mind regardless of economic conditions.
Patrick Farber is a structured settlements broker with Atlas Settlement Group based in Santa Ana, California. He works with attorneys nationally to create structured settlement annuities for physical and non-physical injury cases. He provides support and advice during all phases of the settlement process, and can be reached at 800-734-3910, firstname.lastname@example.org.