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What are Structured Settlements?
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A structured settlement is an option for resolving your personal injury claim. Your tort claim may be settled as a combination of a certain sum and the remainder to the rest the form of an annuity paying out over a period of years instead of one lump sum.
The defendant may purchase an annuity from a structured settlement broker instead of paying you everything up front. From here on insurance company that specializes in handling structured settlements assumes responsibility for paying out damages in the form of periodic payments which “cannot be accelerated, deferred, increased, or decreased by the recipient of such payments” (IRC Section 130. Certain personal injury liability assignments).
The annuity issuer must make a series of payments as negotiated between the defendant and the plaintiff. The recipient usually cannot have more than this predetermined cash flow, no matter the market conditions. So why do many legal and medical practitioners recommend structured settlements as a resolution for personal injury claims? Why would an annuity issuer willingly take up such a burden?
The benefit in this qualified assignment of liability is that both the issuer and the recipient receive tax-free income from the structured settlement.
The coveted tax benefits of Internal Revenue Code Section 130 states that “In general any amount received for agreeing to a qualified assignment shall not be included in gross income to the extent that such amount does not exceed the aggregate cost of any qualified funding assets.”
The structured settlement holder is only taxed on profits gained from managing the fund. The regular payments from the annuity do not even count as income or economic assets. We will discuss the significance of this for your tax bracket and government benefits later.
A structured settlement can be very flexible. For example, you could receive half of the damages you are owed up front, then a regular schedule of payments every month in lieu of a paycheck to cover lifelong economic losses due to how your accident has reduced your ability to work, and a larger lump sum every year your children are expected to go to college.
It is not a perfect solution for every case, however. A structured settlement has several advantages and disadvantages.
Reasons Why You Might Prefer the Lump Sum Payment
First, let us discuss the reasons why a structured settlement may not be your best choice when choosing to settle a claim.
Simplicity
After your case is heard and the negotiations are done, you would be presented with a check to pay off your troubles. There is no one else you have to talk to, no more forms to file, you take it and this difficult part of your life is done. You can put all of it behind you.
Cash it in, and you can do whatever you want with it. Pay off your debts and medical bills, buy a house, send your children to college, have a massive party, and whatever else – no one can stop you. If the settlement is particularly large, you may prefer the feeling of being an instant millionaire.
Greater Dollar Value
The way this works for the defendant is that the liability insurer of the defendant purchases an annuity equal to the remaining money they need to pay out in the settlement. In turn, the issuer may offer rebates to encourage purchase or allow them to pay in stages. The structured settlement insurer in turn manage the funds giving you a set amount adjusted for inflation. If this sounds like holding a trust fund, that’s because that is exactly what it is.
Because the insurance company doling out your structured settlement payments this is a form of investment, upon which they collect commissions, you may actually receive a higher dollar value up front. You may be able to invest it better, with immediate benefits from market growth. The payments are set and non-negotiable.
Liquidity
Similar to the above, the money paid into a structured settlement annuity is illiquid – there is nothing you can do with it. Should a sudden emergency arise, unlike stocks and bonds, you cannot ‘cash it in’. There are certain brokers that offer to buy a structured settlement, but often at a very significant discount and a judge will have to be consulted if you really need that money at cost of the future compensation payments you would receive. You may feel that, for example, $20,000 in hand is better than $60,000 in a few years – but that value could have been $100,000 in your hands years ago. It could have been millions if you had invested it in a booming company.
Many offers to buy structured settlements are predatory, trading on people’s fears and short-term desires. Having money in an investment fund you control means money at hand whenever you want it. If you are already skilled at handling money, this means greater returns than the trickle you would get from an annuity.
Holder Solvency Risk
Since a structured settlement broker is handling payments for you, this does mean that if their insurance company goes under the regular payments you expect may reduce or cease. It is usually not a big problem, if the policy is held by a reputable company monitored by the National Structured Trade Settlements Association, but mismanagement is possible.
Reasons to Accept a Structured Settlement Resolution
Many claims smaller than $100,000 are usually settled with a lump sum. However, for larger sums many attorneys strongly recommend a structured settlement payment scheme. What are the advantages?
Guaranteed Tax-Free Income
Structured settlement annuities represent guaranteed income over decades, enough to insulate you from everyday concerns such as household expenses, while also acting as a form of long-term investment that is unmatched by anything else on the market. You do not actually own the structured settlement policy, which may seem a serious drawback, but this does mean that all payments for personal injury claims are completely tax-free. Receiving compensation in one big lump sum will often instantly push you into a higher tax bracket.
More importantly, since these payments are not considered as assets, you are not disqualified from government means programs. For example, if you wish to continue to receive Medicaid support for your hospital and therapy needs, the expectation of payment from a structured settlement does not count anywhere as income that could be deducted from your benefits.
Freedom from Harassment
Let us say you just received a check for half a million dollars. What do you think will happen when people know you’ve got that much in the bank? Suddenly relatives you never realized existed will be dropping in to visit, friends and co-workers will be pitching in ideas for investment, and all sort of opportunists will be asking for money. You become a target for crime.
Because the structured settlement payments are out of your control, people cannot ask you to give money that you do not have. You can have peace of mind that your necessities are cared for without anyone else intruding to tell you what to do about your money.
Freedom from Temptation
The most important value of a structured settlement is how regular payments do not inspire any temptation to overspend. True, this does mean less money available in case of emergencies. On the other hand, this does mean you do not get in over your head with money problems.
This is similar to winning the lottery. Many people dream of winning big in the lottery. However, many studies and interviews have shown that many who did win big at the lottery become miserable at their winnings, wishing they had torn up their winning lotto ticket.
Their windfall did not solve their all their money woes but instead open new ones. People who suddenly gain large amounts of money have the temptation to live big, to spend on luxuries they do not need, and to use their money to buy affection from others. This very often does not end well.
People awarded large sums as compensation are in much the same boat. You may feel that “this will never happen to me!” but as it turns out over 90% of those who receive a lump sum quickly spend it all. Sudden wealth has the capacity to ruin families and relationships.
Your attorney should negotiate for you a series of payments that can deal with your medical and household needs and some extra without drastically impacting your way of life.
Lifetime Security
It is a sad truth that often the compensation paid for after a personal injury often does not equal the damage done to the victim. In serious cases, no matter how much they are paid and the medical care they receive, they do not expect to outlive the lifetime sinecure guaranteed by their structured settlement.
A beneficiary may receive the benefits from the structured settlement annuity after the plaintiff has passed away. For much the same reasons the previous listed advantage, a limited set amount paid monthly ensures they do not misuse the money and end up destitute. These payments retain their tax-free status to the named beneficiary.
Fiscal Management of a Structured Settlement Annuity
It is strongly advised by legal and business professionals that if you are receiving a tax-free annuity, you should not mess with it. Guaranteed payments protect you from changing market conditions or fiscal mismanagement.
If you are the defendant in a personal injury or worker’s compensation case, a structured settlement may provide significant savings in paying damages. The worker would still receive the amount in damages to be paid, but you have to pay only the present value of the annuity sans the interest the amount would gain over the years. This is a win-win situation for everyone – the insurance companies pay out less, the defendant is not tied up in a lawsuit or a drawn-out negotiation, and the claimant and their lawyer feel better for gaining financial stability.
Consult your lawyer to know if a structured settlement is the best fit for your situation.