What a structured settlement is worth today
A structured settlement resolves a claim with periodic payments funded by an annuity rather than a single cheque. It exists because of a specific tax rule: damages for personal physical injury are excluded from income under section 104(a)(2) of the Internal Revenue Code, and when the settlement is structured properly the entire payment, including the investment growth inside the annuity, keeps that exclusion. A lump sum invested afterwards does not — the earnings on it are taxable. That difference is the reason structures are used at all.
The value of the arrangement is not the sum of the payments. A schedule paying $2,000 a month for twenty years totals $480,000, but the last of those payments arrives two decades from now and a dollar arriving then is worth less than a dollar arriving today. Present value is the arithmetic that makes the two comparable: it asks what single amount, invested at a chosen rate, would exactly reproduce the schedule.
That question comes up in three situations. When you are deciding whether to take a structure or a lump at settlement. When a factoring company offers cash for payments you already hold. And when a court is asked to approve such a transfer, which every state now requires under a Structured Settlement Protection Act, backed federally by a 40% excise tax under IRC §5891 on transfers that do not obtain a qualified order.
The formula, and the rate that does all the work
Each payment is discounted from the moment it arrives: PV = Σ Pₖ / (1 + r)^tₖ. Two details in that expression matter more than they look.
Time is measured in years, including fractions. A monthly payment made in the seventh month of the third year sits at t = 2.5833 years, and is discounted by (1 + r) raised to that power. Treating a monthly stream as if it arrived in twelve annual lumps overstates the value slightly, and the error grows with the rate.
The step-up applies by year, not by payment. An annuity with a 3% annual increase pays the same amount for twelve consecutive monthly payments and then steps. The calculator raises the step factor to the number of completed years, so payment 13 is the first one increased.
The discount rate is where all the disagreement lives, because the present value is far more sensitive to it than to any other input. Consider the three-payment example of $1,000, $1,100 and $1,210 growing at 10% and discounted at 10%: each term is exactly $909.09 and the total is $2,727.27, because the growth and the discounting cancel term by term. Change the discount rate to 5% and the same stream is worth 1,000/1.05 + 1,100/1.05² + 1,210/1.05³ = $2,995.36, which is 2,995.36/2,727.27 − 1 = 9.8% more, from a change of five points in a single assumption.
The effective rate in an offer inverts the calculation. Instead of choosing r and computing the value, it takes the cash a buyer is offering and solves for the r that makes the equation balance. That rate is the buyer's yield, and it is directly comparable to any other rate you know — a mortgage rate, a bond yield, a credit card APR. It is a much more informative number than "they offered me 60 cents on the dollar", which says nothing without knowing when the dollars arrive.
Worked example: $2,000 a month for 20 years against a $180,000 offer
A claimant holds an annuity paying $2,000 monthly for 240 payments, starting immediately, with no step-up. A factoring company offers $180,000 in cash.
- Nominal total. 2,000 × 240 = $480,000. This is the number the payments add up to, and it is not the value of anything.
- Timing. The first payment arrives at t = 1/12 = 0.0833 years; the last at t = 240/12 = 20 years.
- Discount each payment. At a 5% annual rate, payment 1 is worth 2,000 ÷ 1.05^0.0833 = $1,991.89. Payment 120, at t = 10 years, is worth 2,000 ÷ 1.05¹⁰ = $1,227.83. Payment 240 is worth 2,000 ÷ 1.05²⁰ = $753.78.
- Sum them. The full 240-term sum comes to $305,886.89.
- Price the offer. 305,886.89 − 180,000 = $125,886.89 of value given up at a 5% assumption, which is 125,886.89 ÷ 305,886.89 = 41.2% of the present value. Solving for the rate that makes the stream worth exactly $180,000 gives an effective rate of 12.84% a year.
Read that last number the way you would read a loan rate, because that is what it is. Selling the stream at an effective 12.84% is borrowing against your own future payments at 12.84% with no possibility of early repayment. Whether that is a good trade depends entirely on what you need the cash for — clearing debt at 24% is a different proposition from funding a discretionary purchase.
How to read the result
Start with the effective rate inside the offer and ignore the headline percentages a broker quotes. An offer described as "75% of your money" tells you nothing, because the same cash for a stream ending in five years and a stream ending in thirty years represent completely different rates. The effective rate is comparable across offers and across alternatives.
Then choose your discount rate honestly. The rate that makes economic sense for you is the return you could actually earn on the cash with comparable safety — a structured settlement annuity is backed by a life insurance company and is about as certain as a private payment stream gets, so comparing it to an equity return is comparing unlike things. If your real alternative is paying off high-rate debt, then that debt's rate is the correct discount rate, and it may well exceed what a factoring company is charging.
Watch the discount to present value figure with the deferral in mind. Payments far in the future are worth a small fraction of face, so a buyer purchasing a deferred lump ten years out can offer what looks like a shocking fraction of nominal while charging a defensible rate. The reverse is also true: a stream that is nearly finished has a present value close to its nominal total, and a large discount on it is hard to justify.
Finally, keep the tax point in view. Payments under a qualified structure are received tax-free; the proceeds of selling those payments to a factoring company are generally not taxable either, but the earnings on the cash once you have invested it are. The tax advantage of the structure is not something the present value calculation captures, and it argues for a lower discount rate than a taxable alternative would.
Present value of $1,000 a month for a fixed term
| Term | Nominal total | At 3% | At 5% | At 8% | At 12% |
|---|---|---|---|---|---|
| 5 years | $60,000 | $55,708 | $53,134 | $49,645 | $45,588 |
| 10 years | $120,000 | $103,762 | $94,766 | $83,432 | $71,456 |
| 15 years | $180,000 | $145,214 | $127,385 | $106,428 | $86,134 |
| 20 years | $240,000 | $180,971 | $152,943 | $122,078 | $94,462 |
| 30 years | $360,000 | $238,422 | $188,660 | $139,978 | $101,870 |
Each figure is the sum of 1,000/(1+r)^(k/12) over the term, computed by this calculator's own formula. Notice how little the 30-year column adds over the 20-year one at higher rates — distant payments contribute very little present value.
What this calculation does not capture
- Life contingency. Payments that stop at death are worth less than guaranteed payments, and this calculator values a guaranteed schedule. A life-contingent annuity needs mortality-weighted discounting.
- Credit risk. The annuity is only as good as the life insurer standing behind it, and state guaranty association limits cap that protection.
- Inflation. Fixed payments lose purchasing power. A step-up partly offsets that; a flat schedule does not offset it at all.
- Transaction costs. A transfer requires court approval, legal fees and sometimes an independent professional advice requirement, all of which reduce what actually reaches you.
- Partial sales. Many transfers involve only some payments or part of each payment; value the exact payments being sold, not the whole annuity.
- Attorney fees on the structure. Where part of a settlement is structured, the contingency fee is normally calculated on the cost of the annuity rather than on the total of the future payments — the contingency fee net recovery calculator handles the rest of that distribution.
Selling payments requires a court order
Every state has a Structured Settlement Protection Act requiring judicial approval of a transfer, on a finding that it is in the best interest of the payee and any dependants. Federal law reinforces it: IRC §5891 imposes a 40% excise tax on the factoring discount unless the transfer is approved by a qualified order. Those requirements exist because the effective rates in this market have historically been high. Get independent professional advice before signing anything, and treat the effective rate this calculator reports as the central fact for the judge as well as for you.
Structure or lump sum at settlement
The decision at settlement is different from the decision to sell later. At settlement you are choosing between a lump sum you invest yourself and a stream whose entire return is tax-free. The structure wins on tax, on protection against dissipation, and on the certainty of the cash flow; the lump wins on flexibility and on the chance of a higher return. Where the claimant is a minor, has a permanent disability, or is receiving means-tested benefits, the structure usually has strong non-financial arguments in its favour — though a special needs trust is often the better vehicle for the benefits question.
The same discounting arithmetic underlies several other calculations in a claim. Future wage loss is a stream discounted to today, which the lost earning capacity calculator handles with wage growth and work-life expectancy in place of a fixed schedule. Front pay in an employment claim is the same idea over a shorter horizon — see the wrongful termination damages calculator. And where the settlement being structured came from an injury claim, the gross figure it starts from is what the personal injury settlement calculator assembles.
One practical note on comparing offers: ask each buyer for the payments they intend to purchase and the exact cash amount, then compute the effective rate yourself. Buyers quote in whatever way flatters the offer, and the rate is the only figure that survives translation between them.
Key terms
- Qualified assignment
- The mechanism under IRC §130 by which a defendant's obligation to make future payments is transferred to an assignment company that funds it with an annuity, preserving the tax exclusion.
- Factoring company
- A buyer of structured settlement payment rights, who pays cash today in exchange for future payments and profits from the discount.
- Effective annual rate
- The single annual rate at which the payments, discounted from their actual dates, equal the cash offered. The buyer's yield.
- Step-up
- A contractual annual increase in the payment amount, often 2% or 3%, intended to offset inflation over a long schedule.