After one is awarded a structured settlement or annuity payment, it is very easy for an individual to be overcome with emotion with knowing that there is a large sum of money coming their way. While it is great to know that the case ended in a positive outcome with a structured settlement, it is important for one to understand all of the different payout options in order to effectively receive the best payments to fit your current and future lifestyle. There are three payout options, including:
- Lump Sum
While each variation of receiving payment has its own pros and cons, a number of former individuals who have been awarded a structured settlement have opted for the lump sum payment. Let’s take a further dive into the taxes that are applied to a lump sum payment.
Let’s face it, we live in a society that is all about instant gratification. We want it all and we want it now. Right or wrong, few people like to wait for anything, so when faced with the option of receiving a massive payday upfront via a lump sum few would turn that down. Those who choose the lump sum option often select this option because they consider themselves savvy investors. Selecting this option helps those beat the long-term market returns by immediately investing the money in high-yield financial options, including real estate, commodities, precious metals, stocks or bonds.
Taxes, Taxes & More Taxes
The downside of an immediate influx of cash is that the actual payout is significantly less than the amount won in the settlement. The taxes on a large lump sum can be quite high, reaching as much as 40%, which can really take a toll on the funds in the settlement. If one elects to receive a lump sum, the Federal tax can be applied at the rate of 20% of the taxable portion of your refund. In addition, if one is a resident of certain states, an additional 5% can be taken out.
The taxes that can be applied on the structured settlement have the effect of rendering the interest on the settlement free of income taxes. To illustrate how taxes can affect a structure settlement through a lump sum payout let’s look at some numbers. Let’s say the settlement was a $100,000 lump sum, or $25,000 per year for 5 years, for a total of $125,000, both tax-free. If one were to take the lump sum and invest it at 6 percent simple interest, and assuming one is in the 33 percent combined income tax bracket, the individual would have about $120,000 at the end of 5 years as opposed to $125,000 from the structured payments. Of course, the actual difference in after tax investment return is the key. Furthermore, if the one receiving the payout were able to invest the lump sum in tax-free bonds with a return equal to or in excess of the actual rate on the structured settlement, one would likely be better off with the lump sum.