by John Darer® CLU ChFC MSSC RSP CLTC
Structured settlements, referring to periodic payments from the classic personal injury version, retain their income tax status when paid to a beneficiary.
Payments under the classic structured settlement are for payment of damages which are of the form excluded under IRC 104(a)(2) or IRC 104(a)(1) in the case of workers compensation payments.
Don't Worry You Can't Get IRD From Eating a Big Mac, Spicy Indian Food or a Chili Dog
Payments from such structured settlements are generally included in the taxable estate of the decedent.
If the present value of the unreceived payments (that will now be going to the beneficiary) together with other assets that form the decedent estate, exceed an exempt amount* an estate tax is due.
A complete discussion of the estate tax cannot be done justice in a short blog post, but generally the estate tax is due within 9 months of death. Furthermore there are estate or inheritance taxes on both the Federal and State levels. Through careful advance planning there are a number of technioques to mitigate the estate tax problem if it exists. For example, some people can effectively "prepay" the estate tax at a discount using life insurance and gift tax exemptions.
If we are talking structured settlements in the non classic sense, such as employment cases, structured attorney fees and other non qualified structured settlements used in taxable damage cases the same estate tax scenario applies. One must however be cognizant of the Income in Respect of Decedent issue (IRD).
IRD is not some new form of gastric reflux or the nickname for a numerical New York City subway line. One could say it's a form of "income reflux". Income In Respect of a Decedent is the name given t o all types of taxable income earned, but not received by the decedent by the time of his or her death. IRD is NOT taxed on the final return of the decedent, instead, it goes on the return of the person or entity receiving the income. Sometimes this is the surviving spouse, sometimes the estate, sometimes some other beneficiary. IRD retains the same tax nature after death as it would have had if the decedent had received the item of income while alive. There is no step-up in basis for IRD items.
*$5MM on a Federal level. Check the state levels in your state.
"These rules have typically been formulated in terms of whether the misrepresentation was “material.” In some states, the insurance company’s right to defend or rescind is further limited by an additional requirement that the matter misrepresented actually contributed to the loss, contingency, event or hazard for which the claim is made. In other words, in a limited number of states, the insurance company may not deny a claim or seek rescission unless a “causal relation” exists between the misrepresentation and the actual loss. Under such statutes or case law, when there is an applicant who falsely claims to be a nonsmoker, the insurance company can escape liability if the then insured dies of lung cancer due to smoking, but not if the insured later dies of AIDS. Finally, in some cases, the insurance company cannot avoid liability even when the policy has been procured through outright fraud".
In addressing the Professional Planner forum, attorney George Berger of the New York law firm Phillips Nizer stated:
"All that the N.Y. Insurance Law requires is that there be a material misrepresentation in the application. Even an innocent misrepresentation will do and the common position taken by the insured that I told the broker or agent the truth but he failed to write it down will not excuse the misrepresentation.
The test for what is material is stated in section 3105 the N.Y. Insurance Law and it says:
"No misrepresentation shall be deemed material unless knowledge by the insurer of the facts misrepresented would have led to a refusal by the insurer to make such contract."
More CommentsIF you are part of the majority that is truthful on your application you should be able to "bank on your policy", even if the indeterminable loss occurs within the contestable period.
When you apply for life insurance, you should carefully review the application BEFORE you sign the application. The application becomes part of the contract and is usually attached thereto, at the back. When you receive your annuity contract from your agent or the company, you should look over the application AGAIN and make sure that your application (that is now part of the contract) is completely truthful and accurately recorded.
What happens if death occurs while after a prepaid life insurance application is pending
A contestability review will be part of the claim review for any claims submitted in the contestability period. The contestability period is two years from policy issue in the majority of states and one year in others. Again it begins as soon as a policy goes into effect. The life insurance company is within its rights to investigate the application and the information submitted for material misstatements. One big example could be if a life insurance applicant has lied about smoking status. There is legal precedent for rescission of a life insurance contract over misstatement of smoking status after presentment of a life insurance claim. [ see Montgomery v Fidelity & Guaranty Life Ins Co , 269 Mich App 126 (2006), where the insured did not disclose his smoking habit on life insurance policy application, although he died in a car accident. The court held that the material misrepresentation warranted rescission of the policy by the insurer