About JMW | Services | Contact Us

The Impact of Life's Other "Certainty"

One simple way to gauge the impact of taxes on our lives is to note the arrival of “Tax Freedom Day”®. This is the day when our nation as a whole has earned enough money to pay off its yearly income tax bill. Tax Freedom Day is computed by calculating the percentage of all income taxes collected, by the sum of what all citizens earned during the year(1). You apply that percentage to a 365-day calendar year and it tells you how many days it takes all of us to pay the full tax bill.

For the country as a whole, this day usually occurs around the end of March but for some unlucky citizens in our area, it takes much longer. In 2012, citizens of New York, New Jersey, and Connecticut, stretch all the way to May 1st, 1st and 5th, respectfully. Why? Easy: these three states impose the highest state and local taxes on top of the federal tax so it takes more days of work to pay it.

All states in the northeastern U.S. levy an individual income tax but local jurisdictions target additional sources as well. These taxes can take many forms: wage taxes, payroll taxes, “local service” taxes and “occupational privilege” taxes. The mechanisms of calculation vary too: some are imposed as a percentage of wages, others piggyback an additional percentage on top of the total federal or the state tax due, and still others just charge flat amounts. Taken together, the added state and local taxes can really add up.

Now comes the new year of 2013 and it brings some of the largest tax increases in history. For the first time since the imposition of the federal income tax, some taxpayers could end up owing over 50% of their income in taxes. Other tax proposals in the pipeline, like caps on itemized deductions and exemptions, stand to further erode net income. As a result, this year New York, New Jersey and Connecticut won’t reach their Tax Freedom Days until even later: May 6th, May 4th and May 13th.

Why is this relevant to structured settlements? Because structured settlements sidestep the whole scenario - EVERY day is a Tax Freedom Day for structured settlement recipients. In fact, rising income tax rates just make structured settlements that much more valuable as a settlement tool.

To put this into perspective, let’s say a claimant is going to receive a settlement of $400,000. They could either take cash or have it paid out over time as a structured settlement. If paid over 20 years, the final structured sum would grow to $500,000 and the claimant would receive that full amount, unreduced by income taxes.

If they take the $400,000 in cash, they get tax-free that one time but as soon as they invest it (if they actually ever invest it), not only are their returns reduced by investment fees and expenses, but now the investment gains and income are subject to taxes as well. This combination of investment expenses and taxes takes a bigger bite out of their returns than most people realize; indeed, few ordinary investors even know what they are being charged.

The impact of those costs makes structured settlements surprisingly competitive. In fact, a non-taxable structured settlement yielding 3% can potentially put more money in a claimant’s pocket than much higher yields subject to these costs.

For example, a claimant from New York City in the 35% federal tax bracket must add in state income tax of 7.85 percent and local tax of 1.005 percent for a total tax rate of 43.85%. That drives the taxable equivalent yield of this structure up to 5.34% and that’s before you factor in investment fees and costs. Remember: we are talking about fully guaranteed payments here, not hoped-for returns. Compare this yield to government bonds or other highly secure investments and the structured settlement shines.

When you factor in the impact of taxes, an offer in the form of a structured settlement will be financially superior for a significant number of claimants than a cash offer of the same amount.

Contemplate a claimant’s specific needs and craft tailored streams of guaranteed and tax-free income to meet them and you will convert serious settlement offers into compelling – and acceptable - ones.

Want help crafting higher-value settlements? Call Frank C. Kilcoyne, CSSC at 800 544 5533. I am here to help.

(1) Using figures reported by the Bureau of Economic Analysis
For more information on Tax Freedom Day go to: http://taxfoundation.org/tax-topics/tax-freedom-day