IRC 5891 (Commutation)
Section 5891 of the Internal Revenue Code regulates factoring transactions (selling annuity payments) or commutation (turning annuity payments into a lump sum immediate payment). Any company that does not comply with 5891 gets hit with a 40% excise tax on the transaction. A court must make a finding that it is in the best interest of the annuitant to sell/commute the annuity payments. If the factoring transaction or commutation is allowed there are no adverse tax consequences for any of the parties. Because of the way 5891 was written, if a life insurance company is provided with a qualifying order under 5891 they themselves can commute the annuity to a single lump sum payment. Some life insurance companies may do this at the rate they normally charge when an estate planning commutation rider is used which is 6 – 7%.
5891 is an important addition to the law because it gives structured settlement recipients some flexibility. If there is a large future medical need that arises suddenly they can request a commutation under IRC Section 5891. If unforeseen financial circumstances arise, they can pursue the 5891 option. Finally, on structured settlements that were done without an estate planning rider, they can use 5891 to provide sufficient liquidity to take care of estate taxes.
Please check back soon for the full text of IRC 5891 (Commutation).
Most states also have state laws that protect structured settlements recipients in the event of a sale of some or all of the future periodic payments. You should check your state law to see if there is a state structured settlement protection act.