If you’re a plaintiff navigating a legal settlement, you may be wondering how much money you’ll actually get to keep after taxes and legal fees.
Getting a legal settlement or judgment often sounds like you’ll be getting a windfall of cash. But you may be surprised to learn that roughly half or even more of your settlement could go towards taxes, especially if you receive a large lump sum payment.
With the right planning, you can reduce how much you pay in taxes and keep more money in your pocket.
This article will explain how structured settlement annuities can dramatically reduce your tax bill and help you keep more of your hard-won settlement.
But before we dive in, please note that this article contains general information only and should not be considered tax advice.
Is my settlement taxable?
The first thing a plaintiff needs to figure out is whether or not a legal settlement is taxable.
Click here for a more in-depth article on the topic, but here’s a high-level overview:
- The general rule is that legal settlements and court judgments are taxable unless the lawsuit was brought due to a personal physical injury or physical sickness.
- Whether or not a settlement will be taxable depends on what the plaintiff was seeking damages for in bringing the lawsuit. This is known as the “origin of the claim” rule.
Let’s look at a few quick examples.
Example #1:Assume you sue your employer for lost wages, discrimination, or wrongful termination. Your settlement will be taxed as ordinary income, and you will have to pay taxes on the settlement.
Example #2:Assume you settle a defamation lawsuit against a website that posted false information about you. Your settlement will be treated as ordinary income, and you will have to pay taxes on your settlement.
Example #3: Assume you were involved in a car accident that physically injured you, and you file a lawsuit against the negligent driver. Any settlement you receive as compensation for your physical injuries is non-taxable — or tax-free — under Section 104 of the tax code.
The most common type of tax-free settlement is those that are received as compensation for a personal physical injury, as outlined in Section 104 of the tax code.
The bottom line is that the majority of legal settlements are taxable unless you have a strong documented claim for personal physical injuries or physical sickness.
Structured Settlement Annuity: A Strategy to Reduce Your Taxes
If your settlement IS taxable, you can use several planning strategies to reduce your taxes. Let’s focus on just one strategy called a structured settlement annuity and how it helps in cases where the plaintiff will have to pay income taxes on the settlement they receive.
***Please note that structured settlement annuities help in both taxable cases and tax-free personal injury cases. This article focuses on the benefits of using a structured settlement annuity in cases where the plaintiff will be taxed on the settlement. (For more information on how a structured settlement annuity helps in personal injury settlements, please click here to learn more.)
Here’s how a structured settlement annuity helps in taxable cases: Rather than receiving a lump sum when the case settles, a structured settlement annuity allows the plaintiff to spread out the receipt of the settlement over several tax years.
By doing this, the plaintiff only pays taxes on the settlement payments when they receive them in future years. When you spread out a settlement over multiple years, plaintiffs are often taxed at a lower tax rate each year on each payment compared to if they received the entire amount in one year.
By spreading out the payments, you avoid being taxed in the highest tax bracket, which would likely happen if you received all the taxable settlement money in one lump sum.
For example, if a plaintiff receives a $3 million net settlement, they would pay taxes at the highest marginal tax rate (for example, a federal tax rate of 37%) on the entire $3 million.
However, if the plaintiff uses an annuity to spread out those payments over multiple years, say seven years, for example, they may pay only at a 25% tax rate because they will be in a lower tax bracket. This results in a lower total tax bill over the seven years — and much more money in their pocket.
Another major tax benefit of using a structured settlement annuity is that the funds grow at a guaranteed rate inside of the annuity. In other words, when money is put into an annuity, the money is invested by the annuity company — and the plaintiff benefits from the growth of those funds when they receive the payments.
This means the total amount paid out of the annuity is MORE than what the lump sum amount would have been.
For instance, in the prior example above with the $3M net settlement, if the plaintiff places those funds into an annuity that pays over seven years, they may receive closer to $4M million in total payments due to the internal growth in the annuity.
Protection and Stability
An additional benefit of using an annuity is that it provides financial stability to the plaintiff when compared to receiving a large lump sum.
When receiving a lump sum, many plaintiffs may be tempted to spend the money quickly or may be approached by friends, family, and neighbors with “business ideas.” Annuities protect against bad decisions — and the guaranteed payments over several years bring significant financial security and peace of mind.
Your Next Steps: Discover if a Structured Settlement Annuity is Right for You
Paying a bunch of taxes after receiving money from a taxable lawsuit can be devastating. Taxes can take a huge chunk of your recovery if you don’t plan ahead. Using a structured settlement annuity can help you legally reduce your tax bill and maximize the amount you keep after settlement.
We often work with plaintiffs across the country who are able to double their after-tax net settlement by using an annuity.
If you are getting a legal settlement and are worried about taxes, we can help ease your burden. We are here to guide you through the entire process.
The best way to get started is to schedule a free, no-hassle 15-minute phone call with us so we can discuss your situation.
On the call, we’ll:
- Chat about your case.
- Determine if you have to pay taxes on your settlement.
- If yes, we’ll gather some basic information, and our firm will prepare a personalized tax savings analysis for you at no cost. This custom report will show you exactly how much more you could keep using strategies like a structured settlement annuity.
If you want to get a ballpark estimate of how much money you could save, check out our proprietary, no-cost “Settlement Tax Calculator.” The Settlement Tax Calculator will estimate how much you’ll have to pay in taxes — AND, most importantly, it shows you how much more money you can keep by using several of the strategies we use with our clients nationwide.
Important Note: Make sure to book a call soon since all of the tax-saving strategies we use for plaintiffs must be set up before the settlement is finalized.
You can book your call today by clicking on the button below. We look forward to speaking with you soon!