by John Darer CLU ChFC MSSC CeFT RSP CLTC
Is a Structured Settlement Commutation Rider the Fries to the Burger or “Fries 2 Da Burger”?
In the catchpenny article “Secrets Structured Settlement Brokers Wish You Didn’t Know,” a settlement planner suggests that plaintiffs “should almost ALWAYS consider a commutation rider with their structured settlement”—a pairing as natural as fries with a burger.
A commutation rider offers liquidity to the contingent payee(s) of a structured settlement if the measuring life passes away. To ensure the commutation remains income tax-free, an irrevocable election to commute and the percentage to be commuted must be determined when the structured settlement is initially established.
The Original Purpose of Structured Settlement Commutation Riders
The original purpose of structured settlement commutation riders was to provide flexibility by allowing beneficiaries to convert future periodic payments into a single lump sum, addressing immediate financial needs while still maintaining the benefits of a structured settlement.
Commutation riders tied to the death of the measuring life were introduced in 1997 to provide liquidity for structured settlement beneficiaries, enabling them to cover estate taxes on substantial settlements. This was particularly significant when estate tax filing thresholds were much lower than they are today.
While well-structured life insurance can be a useful solution for providing estate liquidity, the insurability of the annuitant is an important factor. Not all annuitants qualify for life insurance.
Between 1987 and 1997, the filing threshold in effect for IRS Form 706 was only $600,000 The tax applied to qualifying estates is based on the decedent’s gross estate less allowable deductions. For tax purposes, gross estate includes “all property in which the decedent had an interest at the time of his or her death and certain property transferred during the lifetime of the decedent without adequate consideration; certain property held jointly by the decedent with others; property over which the
A unified credit is allowed, and, between 1987 and 1997, the credit was $192,800, the credit equivalent of $600,000 in total taxable transfers. The unified tax rate schedule on taxable estate and gift transfers is graduated from the initial rate of 18 percent to the top tax rate of 55 percent on transfers of $3 million or more.
To put things in even more perspective, the Economic Recovery Tax Act (ERTA) of1981 (Public Law 97-34) significantly altered Federal estate tax law. The Act gradually increased the unified credit from $47,000 to $192,800 over a 6-year period. This effectively raised the exemption and, thus, the filing requirement, from $175,000 to $600,000. Such a low estate tax exemption potentially affected a large number of claims. By contrast, In 2017 the lifetime exclusion amount against the estate tax for 2017 is $5.49 million, up $40,000 from 2016. That is the maximum size of taxable estate that can escape tax for those who die in 2017. So from a purely federal estate tax standpoint, in 2017 a commutation rider only benefits a very small population of plaintiffs**. Note that state inheritance taxes may apply with lower exempt amounts.
“Liquifies the remaining value of the annuity”
The settlement planner opines in a memo circulated to trial lawyers, that “the benefit to using this rider is that it liquefies the remaining value in the annuity so that the estate can be probated and distributed without waiting perhaps years for all the remaining guaranteed payments to trickle in”.
- Fact: All structured settlement commutation riders pay a percentage (generally between 90-95%) of the present value. Hence the statement ” liquefies the remaining value” is false and misleading.
- Fact: Naming a beneficiary, means that payments bypass probate at the death of the measuring life, with or without a commutation rider.
Does Structured Settlement Commutation Rider Have Anti-Factoring Appeal?
- Showcased in a way that would make Peachtree Settlement Funding proud, the settlement planner sells the benefit “Without waiting perhaps years for all the remaining guaranteed payments to trickle in”
- The settlement planner then reasons that “the discount available from the annuity company should be a whole lot less than the double digit discounts that most factoring companies offer”. Such a blanket statement is misleading as most discount rates have come way down.
- Furthermore, there is an ongoing conflict involving “plaintiff-loyal” settlement planners who promote structured settlement receivables, presenting themselves as “fiduciaries.” They aim to secure the best rate for an investor client, all while knowing that the same group of annuitants they often work with is being exploited—or has already been exploited—on the other side of the deal. The settlement planner has recommended that personal injury clients as investors purchase of structured settlement payment rights from the very same class of annuitants that he claims to protect.
- Another dubious selling point from the settlement planner “commutation rider don’t require a court hearing like factoring does”.
The need for a qualified order is a requirement of the Internal Revenue Code Section 5891 and Structured Settlement Protection Acts in effect in the majority of states. Given what I and others have documented, the court approval process is not a panacea. But in many cases it works well. Setting aside the high stink factor and the need for improvements to regulation, factoring of structured settlements is, in its purest sense, a response to real time changing needs. A structured settlement commutation rider is an irrevocable election made at the time of settlement whose operation may not come into play for many years, or not at all.
Relevant Related Reading
- Structured Settlement Commutation Riders FAQ | What You Need to Know About Commutations
- Structured Settlement Commutation Riders with SNTs Best Practices
- Estate Cannot Commute Structured Settlement to Lump Sum IF…
Why Name a Beneficiary on a Large Structured Settlement for a Minor?
Federal Estate Tax Returns 1995-1997 an IRS publication by by Barry W. Johnson and Jacob M. Miko
**one example would be where the marital deduction does not apply when the spouse who inherits isn’t a U.S. citizen, even if the spouse is a permanent U.S. resident. The federal government doesn’t want someone who isn’t a citizen to inherit a large amount of money, pay no estate tax, and then leave the country to return to his or her native land.
Still, keep in mind you can leave assets worth up to the exempt amount ($5.49 million in 2017) to anyone, including your non-citizen spouse, without owing any federal estate tax. And if the non-citizen spouse dies first, assets left to the spouse who is a U.S. citizen do qualify for the unlimited marital deduction.
Image: © Ariwasabi | Dreamstime.com