What is the Difference between Qualified and Non-Qualified Structured Settlement Annuities?

What is a non-qualified annuity versus a qualified annuity? Most personal injury cases that use a structured settlement annuity are considered qualified structured settlement annuities. It’s a tax term that delineates between the tax-free nature of the personal injury structured settlement annuities, and the taxable nature of non-qualified structured settlement annuities.

When to Use Non-Qualified Structured Settlement Annuities

If the case is based on a personal, physical injury, the client has access to a tax-free qualified structured settlement annuity. (See IRC 104(a)2 and IRC 130.) 

However, for employment litigation, defamation, or any other type of damage that isn’t a personal, physical injury, then the tax treatment is different for those recoveries. Any settlement or judgment resulting from one of these types of cases is a taxable damage award. As a result, the client has to consider the tax implications of receiving that settlement. 

In these types of cases, a structured settlement annuity for a taxable damages case may make even more sense than it does in a tax-free personal injury situation.

For example, if you have a client that’s going to receive $300,000 in a settlement in an employment litigation case, when that client receives that $300,000 settlement in the current tax year, the client will have to pay taxes on the full amount of that recovery in the same year unless the client spreads out the receipt of the settlement over multiple tax years through the use of a non-qualified structured settlement annuity. 

Thus, a non-qualified structured settlement annuity for a taxable case effectively spreads out the tax treatment on the recovery. Instead of your clients paying a huge lump sum in taxes in the year in which they receive the settlement money, they can spread that tax out over the next several years — and they’re earning interest on that full amount inside the annuity that whole time as well. 

In sum, using a non-qualified structured settlement annuity allows clients who receive settlements from cases other than personal injury to spread out the taxes over several tax years rather than getting taxed on the entire amount in the year of receipt.