by John Darer CLU ChFC MSSC CeFT RSP CLTC
What is a Structured Settlement COLA?
COLA stands for Cost Of Living Adjustment. A Structured Settlement COLA is an optional fixed upward annual adjustment in future periodic payments. No ice cubes or wedge of lime or lemon needed. The Structured Settlement COLA option must be elected before a settlement is concluded and must be properly reflected in settelment documentation.
Question: Is Structured Settlement COLA Taxable?
Comment: In short, providing we are referring to the definition of structured settlement that appears in Section 5891 of the United States Internal Revenue Code, NO.
IRC 130(c)(2)(A) states that periodic payments must be "fixed and determinable as to amount and time of payment." Then Section 130(c)(2)(B) states that "such periodic payments cannot be accelerated, deferred, increased, or decreased by the recipient of such payments."
Should there be a variable future income stream, as there was when Transamerica Occidental Life introduced a CPI linked structured settlement in the 1990s, it is essential to be able to demonstrate that at no time did the payment recipient have any ability to "increase, decrease, accelerate or defer" any payment. The ability or right to do so could trigger the application of the constructive receipt doctrine. Transamerica obtained a Private Letter Ruling from the IRS for its product which is no longer on the market. Transamerica stopped writing structured settlement annuities in the mid 2000s.
What people loosely refer to as a COLA today generally refers to a fixed increase such as 2%, 3%, 4% or more. These "COLA"s are really "the Un COLA" because there is no floating link tied to the rise or fall of the Consumer Price Index (CPI). However these fixed increases are predetermined and documented at the settlement of the case, when the structured settlement is created and are "fixed and determinable as to amount and time of payment...can't "increase, decrease, accelerate or defer"... yada yada...
CAUTION:
- If the "Un COLA" is applied to a structured attorney fee, where the entire amount of each payment received by the attorney is taxable, THEN obviously the incremental benefit represented by the "Un COLA increase factor" IS taxable.
- Similarly, if there is a component of damages that is taxable such as punitives, wrongful termination, environmental, or the portion of a settlement allocated to pre-judgment interest, THEN the incremental benefit represented by the "Un COLA" applied to any periodic payment solution IS also taxable
- Where the "Un COLA" is applied to a non qualified assignment (often called "tax deferred structured settlement") where taxable damages are the order of the day, THEN obviously the incremental benefit represented by the "Un COLA" applied to any periodic payment solution IS also taxable
Postscript:
While not specifically tied to the Consumer Price Index, in 2014 Pacific Life Insurance Company (Pacific Life and Annuity in New York introduced an Index Linked Annuity Payment Adjustment Rider, known by the acronym ILAPA. Corebridge subsidiary American General introduced Interest Rate Linked Structured Settlements (IRLSS) after the nadir in interest rates during the Covid-19 Pandemic. Subsequenty, in late 2021, Independent Life Insurance Company introduced iStructure, payments for which adjustments are tied to changes in the Franklin Bank of America World index and in October 2023, Prudential Insurance Company of America introduced a next generation index linked structured settlement annuity Income Advantage, which offers more choices. Another next generation index linked structured settlement annuity is in the works and may be released later in 2024. Structured settlements established using these products as funding vehicles need a "promise to pay" as part of the consideration in the settlement agreement in addition to other requirements that the indivdual annuity issuer may require.
Last updated April 14, 2024
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