A structured settlement payout is a stream of fixed installments funded by an annuity, paid out on a schedule locked in when your case settles. For physical injury claims, every payment is tax-free under federal law, including the growth built into the annuity.1Office of the Law Revision Counsel. 26 U.S. Code 104 – Compensation for Injuries or Sickness You can sell future payments for cash sooner, but it takes court approval and you will receive substantially less than the payments are worth.
How Your Payment Schedule Is Set
The schedule is negotiated during settlement and fixed once the annuity is purchased. After that, neither you nor the payer can change it. Common designs include monthly payments for ongoing living expenses, annual payments, scheduled lump sums timed to milestones like college or retirement, and payments that step up 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 lives at the design stage. Federal tax law requires the payments to be fixed in both amount and timing, and you cannot speed them up, delay them, or change the amounts once the annuity is in place.2Office of the Law Revision Counsel. 26 USC 130 – Certain Personal Injury Liability Assignments That rigidity is the price of the tax treatment, and it also protects recipients from the well-documented risk of running through a large lump sum in a few years. The annuity itself is backed by a life insurance company, so your payments do not ride on the stock market or on the defendant’s future financial health.
How the Payments Are Taxed
Periodic payments from a structured settlement for physical injuries or physical sickness are excluded from gross income under Section 104 of the Internal Revenue Code. The exclusion covers the full amount of each payment, including the investment growth built into the annuity. Congress wrote the statute to cover damages “whether as lump sums or as periodic payments,” so the implicit return the annuity earns over time passes to you without a tax hit.1Office of the Law Revision Counsel. 26 U.S. Code 104 – Compensation for Injuries or Sickness
That is a real advantage over taking a lump sum and investing it yourself. If you received $500,000 upfront and put it in the market, every dollar of return would be taxable. With a structured settlement, the annuity grows and pays out more over time, all tax-free. Across 20 or 30 years, the difference compounds into a substantial amount of additional money.
When Payments Are Taxable
Not every structured settlement qualifies. The exclusion applies only to compensatory damages for physical injuries or physical sickness. The IRS treats the following as taxable income:3Internal Revenue Service. Tax Implications of Settlements and Judgments
- Damages for emotional distress, defamation, or humiliation that are not connected to a physical injury.
- Back pay and emotional distress damages from Title VII and similar employment discrimination claims.
- Punitive damages, taxable in nearly all cases, with a narrow exception for wrongful death claims in states where punitive damages are the only remedy available.
Emotional distress damages get a partial carve-out: you can exclude amounts that reimburse you for actual medical care expenses attributable to the emotional 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, the way the settlement agreement allocates the funds between those categories matters at tax time.
Effect on SSI and Medicaid
If you receive means-tested benefits, the payout needs careful handling. 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 fall in the same range. Settlement payments that push your countable assets above those limits can suspend your benefits.
Periodic payments help somewhat, since you receive smaller amounts over time. But each payment still counts as income in the month you receive it and as a countable resource if you save it. Social Security Disability Insurance and Medicare are not affected by settlement proceeds, because those programs are not means-tested.
Using a Special Needs Trust
A special needs trust lets you receive settlement funds without jeopardizing benefit eligibility. The annuity’s payee is the trust rather than you directly, so the money flows into the trust and is managed on your behalf. Because the trust owns the assets, they do not count toward your SSI or Medicaid resource limits. The trust can spend money on things those programs do not cover, like education, transportation, recreation, and personal items.
One tradeoff: federal law requires first-party special needs trusts to name the state Medicaid agency as the remainder beneficiary. When you pass away, Medicaid gets reimbursed for benefits it paid before any remaining funds pass to your heirs. Setting this up at the time of settlement, rather than restructuring an existing payment stream later, is much simpler and less expensive. If you are on means-tested benefits when your case settles, this is the single most important planning step to take.
Selling Future Payments for a Lump Sum
Selling structured settlement payments, known as factoring, means exchanging future payments for a smaller amount of cash today. The factoring company pays you less than the payments are worth because it absorbs the time value of money and its transaction costs. The gap between what your payments total and what you receive is called the factoring discount, and it is larger than most people expect.
Discount rates in this market typically run between 9% and 18%, and can go higher. On $100,000 in future payments spread over 15 years, you might receive somewhere between $40,000 and $70,000 today, depending on the rate, the timeline, and the buyer. The longer the remaining payment period, the steeper the discount. Sit with those numbers before signing anything.
Partial Sales Instead of Selling Everything
You do not have to sell the whole stream. A partial sale converts some future payments to cash while keeping the rest intact. You can sell a specific number of payments, such as the next 36 monthly installments, or payments from a specific date range. After the sale closes, the remaining payments continue on the original schedule.
Partial sales are worth serious consideration even when you think you need to sell everything. 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 structured settlement transfer requires advance court approval. It is not optional. 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 takes effect.5Office of the Law Revision Counsel. 26 USC 5891 – Structured Settlement Factoring Transactions
To issue the order, the judge must find that the transfer does not violate any federal or state law, is in your best interest, and takes into account 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 at the hearing to 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 have considered alternatives. From petition filing to final order, the process typically takes 60 to 90 days.
Federal law backs up the approval requirement with a 40% excise tax on the factoring discount if a company acquires payment rights without a qualified order.5Office of the Law Revision Counsel. 26 USC 5891 – Structured Settlement Factoring Transactions The tax falls on the buyer, but it makes unapproved transfers economically unviable. Any legitimate factoring company will insist on court approval before closing. If one suggests otherwise, walk away.
Disclosures and Protecting Yourself Before You Sign
State structured settlement protection acts require the factoring company to give you a written disclosure statement before you sign the transfer agreement. It must spell out the amounts and due dates of the payments you are giving up and their total value, the discounted present value using the Applicable Federal Rate, the gross and net amounts you will receive, an itemized list of transaction costs, and the effective annual interest rate you are paying the company. It must also tell you that you have a right to cancel the agreement within a set window after signing, commonly three business days, and a right to seek independent professional advice first.
Several states require you to actually obtain that independent advice from an attorney, accountant, or financial planner before the transfer can proceed. Even where it is not mandatory, use it. An advisor with no connection to the factoring company can tell you whether the terms are reasonable and whether selling makes sense given your full financial picture.
The factoring market has a documented history of aggressive tactics, including persistent phone campaigns and deeply discounted offers to people under financial pressure. Before agreeing to any transfer:
- Contact at least three factoring companies. Discount rates vary significantly, and a few percentage points translate into thousands of dollars.
- Add up the total value of the payments you are giving up and compare it to the cash offer. If you are receiving 30 cents on the dollar, understand that clearly before signing.
- Sell only what you need. A partial sale preserves long-term income while meeting the immediate cash need.
- Get independent advice from someone unconnected to the buyer.
- Do not let anyone rush you. The disclosure period and court process exist to give you time to reconsider. Pressure to move faster than the law allows tells you something about the company.
The court hearing is your final safeguard. Judges do reject transfers they find are not in the payee’s best interest, and they look closely at whether you understood the trade-off. Come prepared to explain why you need the cash, what alternatives you considered, and how you plan to use the lump sum.