If you have a severe personal injury because of the fault of someone else, you may be able to make a claim against that person or their insurer for compensation.
A personal injury case may arise from:
- medical negligence
- sporting accidents
- motor vehicle accidents
- public liability
- product liability.
The periodic payments you receive from a structured settlement or structured order entered into on or after 26 September 2001 are tax-exempt (tax-free). The components of your structured settlement must satisfy certain conditions to be eligible for the tax exemption.
Prior to 26 September 2001, annuities you receive from a structured settlement were taxable income.
For more information, see Taxation Laws Amendment (Structured Settlements and Structured Orders) Act 2002.
Structured settlements are the result of an agreement between the parties to a personal injury case. The parties to the settlement will generally be the injured person or their legal personal representative, the defendant and their insurer.
A structured settlement is a way of settling a claim for personal injury compensation. The injured person (claimant) receives at least part of their compensation in the form of tax-exempt periodic payments (annuities) instead of receiving a lump sum settlement.
A structured settlement can only be entered into by the injured person or their legal personal representative.
It is not possible to have or enter into a structured settlement:
- where the person has died
- after the parties have settled the case or a court has awarded damages.
There is no special requirement under the tax legislation for structured settlements to be approved by a court. There may be other reasons why court approval must be obtained (for example, one of the parties to the claim is under a legal disability).
Once an arrangement occurs for a structured settlement, you can't change it or cash it out for a lump sum. A structured settlement may have a number of components – for example, a compulsory and optional component.
A structured order will have the same outcome (and components) as a structured settlement, with at least part of the compensation being paid in the form of periodic payments.
A structured order is the result of an order that has been made by a court, often without the consent of the parties.
Structured orders are only possible where a court has power to impose a judgment involving periodic payments of the type satisfying the tax rules for structured orders.
Structured orders are far less common than structured settlements.
A structured settlement will contain a compulsory component (personal injury annuities that provide you with a minimum level of monthly payments for as long as you live) and other optional components.
To be tax-exempt the personal injury annuity component is compulsory, it must satisfy the following conditions:
- the source of 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
- the payments allowed
- the frequency of payments
- the term or length of the annuity, which must be at least for 10 years or for the life of the injured person
- the date for the commencement of the annuity
- the date of payment
- 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 personal injury annuity or annuities must satisfy the requirement for the minimum monthly level of support.
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. These must also increase in line with the All Groups Consumer Price Index (CPI) or full-time adult average weekly ordinary time earnings (AWOTE) or by a percentage specified in the annuity instrument.
Example: structured settlement involving a series of personal injury lump sums
Robert was involved in a motorbike accident with another vehicle and suffered a spinal cord injury resulting in quadriplegia. The other driver was at fault as they ran a red light.
Robert engaged a lawyer to make a claim for compensation for personal injury against the motorist. The motorist was insured and the insurance company defended the claim on their client's behalf.
The parties reached the following structured settlement agreement:
- The insurer will pay Robert an immediate cash lump sum of $565,000 (an optional component) that he can use this amount to pay his lawyers, pay off his debts and purchase some equipment.
- The insurer will also purchase a personal injury annuity (compulsory payment) that will provide Robert with periodic payments, starting at $2,000 per month and continuing for as long as he lives. The payments are indexed to increase in line with the CPI and are guaranteed for 10 years from the date of settlement. The monthly payments will be used to cover his medical expenses and other living costs.
- The insurer will also purchase a series of personal injury lump sums. These 8 payments are spaced out every 5 years and will be payable if Robert is alive on the agreed payment dates. The agreed timeframes and amounts are as follows
- after 5 years – $10,000
- after a further 5 years – $25,000
- after a further 5 years – $40,000
- after a further 5 years – $50,000
- after a further 5 years – $75,000
- after a further 5 years – $100,000
- after a further 5 years – $150,000
- after a further 5 years – $200,000
It is expected that Robert will use these payments to replace his wheelchair every 5 years and to cover other expenses.
The personal injury annuity payments and the personal injury lump sum payments, including the immediate cash lump sum, will be tax-exempt.End of example
A structured settlement may also include one or more of the following optional components:
- A cash component – an immediate lump sum you receive after the settlement is arranged that you can use to pay your costs, pay any debts, purchase equipment, or invest.
- Other personal injury annuities – these have more flexible conditions than the compulsory minimum annuity.
- Personal injury lump sums – these can provide tax-free lump sums at pre-agreed future dates that are determined at the time of settlement.
For a personal injury lump sum to be tax-exempt, certain conditions must be satisfied. The instrument under which the lump sum is paid must:
- identify the structured settlement or structured order under which the lump sum is paid, that is the source of the money used to purchase the policy
- specify that the lump sum can only be paid to the injured person, or the trustee of a trust of which the injured person is the beneficiary
- specify the dates and amounts of the lump sums
- specify the method of indexation of the lump sum by either the CPI or AWOTE index
- contain a statement to the effect that the right to receive the lump sum can't be assigned, and can't be commuted or otherwise cashed out early.
Example: injured person uses a lump sum to purchase an annuity (not a structured settlement)
David settles a claim against Anne for a personal injury he has sustained. Under the terms of the settlement agreement, Anne is obliged to pay David a lump sum amount. David uses the lump sum to purchase an annuity from a life insurance company.
The annuity is not a personal injury annuity and therefore will not qualify for the tax exemption.
If the settlement agreement had specified that Anne or her insurer would use the lump sum to purchase a personal injury annuity from a life insurance company, the arrangement would be a structured settlement (assuming all the other requirements of the tax legislation were met, including the minimum level of support).End of example