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This fact sheet has been produced to provide financial advisers with basic information about changes to the tax treatment of structured settlements and structured orders. As structured settlements are expected to be far more common than structured orders, they are the primary focus of this fact sheet. See the end of this fact sheet for details on how to obtain further information.
If you would prefer to read this fact sheet in Portable Document Format (PDF), download Structured settlements - information for financial advisers here.
The Taxation Laws Amendment (Structured Settlements and Structured Orders) Act 2002 (the Act) has amended the Income Tax Assessment Act 1997, the Income Tax Assessment Act 1936 and the Life Insurance Act 1995.
The amendments have made personal injury annuities and personal injury lump sums provided under structured settlements and structured orders exempt from income tax. Previously, structured settlement annuities were taxable. The tax exemption will apply to certain structured settlements and structured orders entered into on or after 26 September 2001.
A structured settlement is a way of settling a claim for personal injury compensation. These claims will be common law negligence claims for motor vehicle accidents, sporting accidents, public liability, product liability or medical indemnity. Structured settlements are not possible for workers' compensation type claims.
Only the injured person or their legal personal representative can enter into a structured settlement. It is not possible to have a structured settlement where the person has died.
Structured settlements are the result of an agreement between the parties to the personal injury case. The parties will generally be the injured person or their legal personal representative, the defendant and their insurer. Instead of the injured person receiving a single lump sum payment of compensation from the defendant or the defendant's insurer, they receive all or part of their compensation in the form of tax-exempt periodic payments (annuities). It is not possible to enter into a structured settlement after a court has awarded damages.
An injured person can only enter into a structured settlement if the lump sum compensation payment, that would have been awarded if a court decided their case, would have been a tax-free capital payment.
A structured order is made by a court, often without the agreement of the parties. It will have the same outcome and components as a structured settlement and must satisfy the same conditions to be tax-free.
There can be several components to a structured settlement.
- A structured settlement must involve the purchase by the defendant or their insurer of one or more personal injury annuities that provide the injured person with a minimum monthly level of support equal to the age pension and pension supplement. This component is compulsory for all structured settlements.
- A structured settlement will usually include an immediate cash component being paid to the injured person. This immediate lump sum can be used by the injured person to pay costs, pay debts or purchase equipment. This component is optional but most people will need some cash immediately after the settlement of their case.
- A structured settlement that includes a personal injury annuity providing the minimum monthly level of support may also include
- other personal injury annuities (which have more flexible conditions than the compulsory minimum annuity), and/or
- personal injury lump sums, which can provide tax-free future lump sums at pre-agreed future dates.
This component is optional.
What is a personal injury annuity?
A personal injury annuity is an annuity that is purchased under the terms of a structured settlement. In order to be treated as tax-exempt it must satisfy certain conditions set out in the Act:
- The money used to purchase the policy must come from the settlement.
- The annuity must be purchased from an Australian life insurance company or a State insurer.
- The wording of the policy instrument, in terms of identifying the structured settlement, should specify to whom the payments can be made, and not allow for commutation (that is the conversion of the annuity into a lump sum payout) or assignment (that is the transfer to another person).
- The agreement must specify
- payments allowed
- the frequency of payments
- the term or length of the annuity
- the date for the commencement of the annuity
- the date of payment, and
- the allowed basis for increases.
- The agreement must specify the guarantee period (if any) including who will receive the annuity payments in the event of death of the injured person.
- The requirement for the minimum monthly level of support.
- The personal injury annuity or annuities must satisfy the requirement for the minimum monthly level of support.
This last condition requires that the personal injury annuity (or a combination of these annuities) must provide the injured person with a monthly amount that equals or exceeds the minimum monthly level of support. This effectively requires a lifetime annuity providing monthly payments that are equal to or more than one-twelfth of the current annual age pension and increase in line with the All Groups Consumer Price Index or full-time adult average weekly ordinary time earnings or by a percentage specified in the annuity instrument.
Once such an annuity is in place, other personal injury annuities are allowed which are more flexible regarding payment term, payment frequency and indexation. These other annuities need not be for the life of the injured person (they must have a term of 10 years or longer, provided the payments stop when the injured person dies), must be paid at least annually and the payments need not be indexed, or can be indexed in a range of different ways.
Under a structured settlement, personal injury annuity payments can be guaranteed for up to 10 years. If a guarantee period of 10 years is chosen this will mean that if injured persons die within 10 years from the date of settlement then the remaining payments (that would have been paid if the injured person had lived out the 10 years) can be paid tax-free to their dependants. If the dependants wish to, they can commute the remaining payments to a lump sum. If the remaining payments are to be paid to the injured person's estate, they must be paid as a lump sum. If the personal injury annuity commences after the date of the settlement the guarantee period will be less than 10 years. It will not be possible to have a guarantee period if the personal injury annuity is to commence later than 10 years after the date of settlement. The guarantee period only applies to personal injury annuities.
What is a personal injury lump sum?
Where there is a personal injury annuity in place that meets the minimum monthly level of support, a structured settlement may also include one or more personal injury lump sums.
The concept of a personal injury lump sum essentially involves a single premium being paid in return for an agreement to pay a lump sum at an agreed future date or dates. These payments can be scheduled to cover expected future events such as the replacement of equipment.
The lump sum can be paid only to the injured person or their trustee. Therefore the payments are life-contingent; they can only be paid if the injured person is alive at the agreed future payment date or dates.
In order to be treated as tax-exempt the personal injury lump sum must satisfy certain other conditions. The instrument under which the lump sum is paid must:
- identify the structured settlement or structured order under which the lump sum is paid and the source of the money used to purchase the policy, and
- contain a statement to the effect that the right to receive the lump sum cannot be assigned, and cannot be commuted or otherwise cashed out early.
Personal injury annuities and personal injury lump sums are financial products. As a financial adviser you will need to ensure that you satisfy the requirements of the Financial Services Reform Act 2001 and the Corporations Act 2001 in relation to any financial advice provided regarding structured settlements.
Access to Centrelink payments can be affected by the receipt of compensation payments, whether those payments are received in the form of a lump sum or periodic payments. This must be taken into account when providing financial advice on structured settlements.
Where can I find out more information?
If you would like more information about structured settlements you can:
- refer to other fact sheets in this series
- download information from the Tax Office website at www.ato.gov.au
- refer to Division 54 of the Income Tax Assessment Act 1997
- refer to the Taxation Laws Amendment (Structured Settlements and Structured Orders) Act 2002.
For information on the current level of the age pension phone Centrelink on 13 23 00 or visit the Centrelink website at www.centrelink.gov.au
If you do not speak English and need help from the Tax Office, phone the Translating and Interpreting Service on 13 14 50.
Other fact sheets in this series
Copies of the following fact sheets can be downloaded from the Tax Office website at www.ato.gov.au
Last Modified: Tuesday, 21 November 2006