A structured settlement payout arrives as a series of fixed installments funded by an annuity, on a schedule locked in when your case settled. For physical injury claims, every payment is fully tax-free under federal law, including the investment growth built into the annuity.1Office of the Law Revision Counsel. 26 U.S. Code 104 – Compensation for Injuries or Sickness You can convert future payments into a lump sum by selling them to a factoring company, but the sale requires court approval and you’ll receive substantially less than the payments are worth.
How the Payment Schedule Works
The schedule is negotiated during settlement and becomes permanent once the annuity is purchased. Common designs include monthly payments for ongoing living expenses, annual payments, scheduled lump sums at milestone dates such as college enrollment or retirement, and payments that increase over time to account for inflation. Many recipients combine these, pairing steady monthly income with larger lump sums at key life stages.
All the flexibility exists at the design stage. After the annuity is issued, neither you nor the insurer can accelerate, delay, or change the amounts. Federal tax law requires this rigidity: the payments must be fixed in both amount and timing for the arrangement to keep its tax-favored status.2Office of the Law Revision Counsel. 26 USC 130 – Certain Personal Injury Liability Assignments The annuity itself is backed by a licensed life insurance company, so the payments don’t rise or fall with the stock market or with the defendant’s future financial condition.
Are Structured Settlement Payments Taxed?
Periodic payments for physical injuries or physical sickness are excluded from your gross income under Section 104 of the Internal Revenue Code. The exclusion covers the full amount of each payment, including the implicit investment return the annuity earns over time. Congress wrote the statute to cover damages “whether as lump sums or as periodic payments,” so the growth built into the payment stream passes to you without any tax hit.1Office of the Law Revision Counsel. 26 U.S. Code 104 – Compensation for Injuries or Sickness
This is a meaningful advantage over taking a lump sum and investing it. If you received $500,000 upfront and put it in the market, every dollar of return would be taxable. With a structured payout, the annuity grows and pays you more over a 20- or 30-year horizon, all tax-free.
When Payments Are Taxable
Not every structured settlement qualifies for tax-free treatment. The exclusion covers compensatory damages for physical injuries or physical sickness. The IRS treats these categories as taxable income:3Internal Revenue Service. Tax Implications of Settlements and Judgments
- Emotional distress, defamation, or humiliation damages not connected to a physical injury
- Back pay and emotional distress damages from Title VII and similar employment discrimination claims
- Punitive damages, with a narrow exception for wrongful death claims in states where punitive damages are the only available remedy
Emotional distress damages get a partial carve-out: you can exclude amounts that reimburse actual medical care expenses attributable to the distress.1Office of the Law Revision Counsel. 26 U.S. Code 104 – Compensation for Injuries or Sickness Anything beyond those medical costs is taxable. If your settlement mixes physical injury with non-physical claims, how the settlement agreement allocates funds between the categories matters at tax time.
If You Receive Government Benefits
Structured payouts need careful handling when you receive means-tested benefits. SSI enforces a resource limit of $2,000 for individuals,4Social Security Administration. 2026 Cost-of-Living Adjustment (COLA) Fact Sheet and Medicaid thresholds vary by state but often sit in the same range. Payments count as income in the month received and as a countable resource if saved, so they can suspend eligibility. Social Security Disability Insurance and Medicare aren’t means-tested and generally aren’t affected.
A special needs trust is the standard fix. The annuity payee is designated as the trust rather than you, so the money flows into the trust and doesn’t count toward your resource limits. The trust can spend on things public benefits don’t cover, like education, transportation, and personal items. Setting this up at the time of settlement is significantly simpler than trying to reroute an existing payment stream later. If you’re on benefits when your case settles, this is the single most important planning step to take.
Selling Future Payments for Cash
Selling structured settlement payments, known as factoring, exchanges future payments for a smaller lump sum today. The gap between what the payments total and what you receive is the factoring discount, and it’s larger than most people expect.
Discount rates in this market typically fall between 9% and 18%, and can run higher. On $100,000 in future payments spread over 15 years, a realistic cash offer sits somewhere between $40,000 and $70,000 depending on the discount rate, the payment timeline, and the buyer. The longer the remaining payment period, the steeper the discount. Sit with those numbers before committing.
Partial vs. Full Sales
You don’t have to sell everything. A partial sale converts a defined slice of payments into cash while leaving the rest of your income stream intact. You can sell a set number of installments, such as the next 36 monthly payments, or payments falling within a specific date range. Once the sold portion is complete, your remaining payments continue on the original schedule.
Partial sales are worth serious consideration even when you think you need to sell everything. They limit how much long-term value you give up and keep some income protection in place. If your cash need is $30,000 for a medical emergency, selling $30,000 worth of near-term payments is a very different outcome than liquidating a $200,000 stream.
Court Approval Is Required
Every transfer of structured settlement payments requires advance court approval. It’s a requirement under both state structured settlement protection acts and federal tax law. The factoring company files a petition, typically in the jurisdiction where you live, and a judge must issue what federal law calls a qualified order before the transfer can close.5Office of the Law Revision Counsel. 26 USC 5891 – Structured Settlement Factoring Transactions
To issue the order, the judge must find the transfer doesn’t violate federal or state law, is in your best interest, and accounts for the welfare and support of your dependents.5Office of the Law Revision Counsel. 26 USC 5891 – Structured Settlement Factoring Transactions You may need to appear and explain why you need the lump sum and how you plan to use it. Judges look at your age, financial circumstances, whether dependents rely on the payment stream, and whether you’ve considered alternatives. Petitions do get denied. The process from filing to final order typically takes 60 to 90 days.
Before the hearing, state law also requires the factoring company to give you a written disclosure statement covering the amounts and dates of the payments you’re giving up, the discounted present value calculated using the Applicable Federal Rate, an itemized list of transaction costs, the effective annual interest rate you’re paying the company, and your right to cancel within a set window (commonly three business days) after signing. Several states also require you to receive independent professional advice before the transfer can proceed.
The 40% Excise Tax on Unapproved Transfers
Federal law backs the court approval requirement with a severe penalty. If a factoring company acquires your payment rights without first obtaining a qualified court order, it owes an excise tax equal to 40% of the factoring discount.5Office of the Law Revision Counsel. 26 USC 5891 – Structured Settlement Factoring Transactions The tax falls on the buyer, not you, but it makes unapproved transfers economically unviable. On a transaction where a company pays you $50,000 for $100,000 in future payments, the factoring discount is $50,000 and the excise tax would be $20,000. Any legitimate buyer will insist on court approval before closing. If one suggests otherwise, walk away.
Protecting Yourself Before You Sign
The factoring market has a documented history of aggressive tactics, including persistent phone campaigns and deeply discounted offers aimed at people under financial pressure. Before agreeing to any transfer:
- Get at least three quotes. Discount rates vary meaningfully between buyers, and a few percentage points translate to thousands of dollars on a typical transaction.
- Do the math yourself. Add the total value of the payments you’re giving up and compare it to the cash offer. If the company is paying 30 cents on the dollar, know that clearly before signing.
- Sell only what you need. A partial sale preserves long-term income while meeting the immediate cash need.
- Use independent advice. An attorney or financial planner with no connection to the factoring company can evaluate whether the terms are reasonable and whether the sale makes sense for your situation.
- Don’t let anyone rush you. The disclosure period and court process exist to give you time to reconsider. A company pushing you to move faster than the law allows is telling you something about how it does business.
The court hearing is your final safeguard. Come prepared to explain why you need the cash, what alternatives you considered, and how the lump sum will be used.