Structured settlements provide individuals with a steady stream of tax-free payments over a specified period. These settlements are commonly used in personal injury, wrongful death, and workers’ compensation cases to compensate the claimant for their losses.
How Structured Settlements Work?
Structured settlements involve four main parties: the claimant/plaintiff (the injured party), the defendant (the party responsible for the injury), the assignment company, and the insurance company. The process begins when the claimant and the defendant agree to settle the case out of court. Instead of receiving a lump sum payment, the claimant agrees to receive periodic payments over a specified time.
The defendant then transfers their obligation to make these periodic payments to an assignment company or a structured settlement broker. The assignment company purchases an annuity contract from a life insurance company, which will be responsible for making the payments to the claimant according to the agreed-upon terms.
Legal Structure: Assigned vs. Unassigned Cases Of Structured Settlements
There are two types of structured settlement cases: assigned and unassigned. In an assigned case, the defendant transfers their obligation to make periodic payments to a third-party assignment company. The assignment company then assumes the responsibility of making the payments to the claimant. This structure offers additional security for the claimant, as a separate entity now handles the payment obligation.
In an unassigned case, the defendant retains the obligation to make periodic payments directly to the claimant. While this structure may be simpler, it does not provide the same level of security as an assigned case, as the claimant relies on the defendant’s ability to make the payments over time.
Reasons to Choose Structured Settlements?
There are several compelling reasons why individuals may choose structured settlements over lump-sum payments:
Guaranteed Tax-Free Income Stream
One of the most significant advantages of structured settlements is that the periodic payments are tax-free under Internal Revenue Code Section 104(a)(2). This means that claimants can receive their compensation without paying federal or state income taxes on the payments, allowing them to keep more of their settlement money.
Customizable Payment Options
Structured settlements offer flexibility in terms of payment options. Claimants can work with their attorneys and structured settlement consultants to design a payment plan that best suits their needs. This can include immediate payments, deferred payments, lifetime payments, or a combination of these options.
Protection Against Mismanagement of Funds
Receiving a large lump-sum settlement can be challenging, and some individuals may be tempted to spend the money quickly or make poor investment decisions. By receiving periodic payments through a structured settlement annuity, claimants are protected against the mismanagement of their funds, ensuring that they have a steady income stream to meet their long-term needs.
Potential for Higher Total Payout
Sometimes, structured settlements may provide a higher total payout than lump-sum settlements. The annuity used to fund the structured settlement can earn interest over time, allowing the claimant to receive more money in the long run.
Funding for Long-Term Medical Expenses and Living Costs
For individuals who have suffered serious injuries, structured settlements can provide a reliable funding source for ongoing medical expenses and living costs. By receiving periodic payments, claimants can ensure they have the financial resources necessary to cover these expenses over time.
Payout Options for Structured Settlements
Structured settlements offer a variety of payout options to meet the unique needs of each claimant:
Lump-Sum Distributions
In some cases, claimants may receive a portion of their settlement as a lump-sum payment upfront, with the remainder paid out through periodic payments. This can be useful for covering immediate expenses, such as outstanding medical bills or legal fees.
Deferred Payments
Claimants may choose to defer their payments until a later date, such as when they reach retirement age. This can be advantageous for those who do not need the money immediately and want to ensure a stable income stream in the future.
Life-Contingent Payments
Life-contingent payments provide claimants with a guaranteed income stream for the rest of their life. This option can be particularly beneficial for those who have suffered permanent disabilities and require ongoing financial support.
Periodic Lump Sums
Some structured settlements may include periodic lump-sum payments in addition to the regular periodic payments. These lump sums can be used to cover anticipated expenses, such as a child’s college education or purchasing a home.
Increasing or Decreasing Payments
Claimants may opt for payments that increase or decrease over time to account for inflation or changes in their financial needs. For example, payments may be set to increase annually to keep pace with the cost of living.
Payments for Life with Certain Period
This option guarantees payments for the claimant’s lifetime, with a specified minimum number of payments. If the claimant passes away before the minimum number of payments is made, the remaining payments will be made to their designated beneficiary.
Joint and Survivor Annuity
A joint and survivor annuity provides payments to the claimant for their lifetime and continues to make payments to their designated survivor, such as a spouse, after the claimant’s death.
Advantages of Structured Settlements in Financial Planning
Structured settlements offer financial security in several ways:
Tax Benefits
As mentioned earlier, structured settlement payments are tax-free under IRC Section 104(a)(2). This can bring tax savings over time, allowing claimants to keep more settlement money.
Reliable and Stable Income Source
Structured settlements provide financial strength through a reliable and stable income source, as the payments are guaranteed by the insurance company that issues the annuity. This can relax claimants who may be unable to work due to their injuries.
Flexibility to Customize Payments to Individual Needs
The ability to customize payment options allows claimants to tailor their structured settlement to their unique financial needs. This flexibility ensures that the settlement fund is used in the most effective manner possible.
Preservation of Government Benefits
For claimants who receive government benefits, such as Medicaid or Supplemental Security Income (SSI), a structured settlement can preserve their eligibility for these benefits. By receiving periodic payments instead of a lump sum, claimants may be able to maintain their income and asset levels within the required limits.
Avoidance of Investment Risks
Structured settlements eliminate the need for claimants to make investment decisions with their settlement proceeds. The annuity provides a guaranteed stream of payments, removing the risk of potential investment losses.
Disadvantages of Structured Settlements
While structured settlements offer many benefits, there are also some cons to consider:
Lack of Liquidity and Flexibility Once Terms Are Set
Once the terms of a structured settlement are established, they can be difficult to modify. Claimants may not have access to additional funds if their financial circumstances change unexpectedly.
Potential for Selling Payments at a Discount
Some claimants may choose to sell their future structured settlement payments for an immediate lump sum. However, this often results in receiving significantly less money than the total value of the future payments, as factoring companies typically purchase the payments at a discount.
Inflation Risk for Fixed Payments
If a structured settlement includes fixed payments that do not increase over time, the purchasing power of these payments may be eroded by inflation. This can be particularly problematic for long-term settlements.
Opportunity Cost of Not Investing Lump-Sum Payouts
By receiving periodic payments instead of a lump sum, claimants may miss out on potential investment opportunities that could yield higher returns. However, this opportunity cost must be weighed against the risk of investment losses and the benefits of a guaranteed income stream.
Structured Settlements and Government Benefits
Structured settlements can be used as a funding tool for various purposes:
Medicare Set-Asides
In cases where a claimant is a Medicare beneficiary, a structured settlement can be used to fund a Medicare Set-Aside (MSA) arrangement. An MSA is an account that is established to cover the claimant’s future medical expenses related to their injury, ensuring that Medicare does not have to bear these costs.
Special Needs Trusts
For claimants with disabilities, a structured settlement can be used to fund a Special Needs Trust (SNT). An SNT is designed to provide financial support for the claimant while preserving their eligibility for government benefits, such as Medicaid and SSI.
Structured Settlement Cases:
To better understand how structured settlements work in real-life situations, consider the following examples:
Personal Injury Case Study
John, a 35-year-old construction worker, suffered a severe spinal cord injury in a workplace accident. As a result of his injury, John is unable to return to work and will require ongoing medical care. Through a structured settlement, John will receive $5,000 per month for the rest of his life, with an additional $100,000 lump-sum payment every five years to cover anticipated medical expenses.
Workers’ Compensation Case Study
Sarah, a 45-year-old nurse, developed carpal tunnel syndrome due to repetitive strain injuries at work. As part of her workers’ compensation settlement, Sarah will receive $3,000 per month for the next 10 years to cover her lost wages and medical expenses related to her condition.
Wrongful Death Case Study
The family of Michael, a 50-year-old father of two, received a structured settlement after Michael was killed in a car accident caused by a drunk driver. The settlement provides $6,000 per month for the next 20 years to help support Michael’s children and cover their education expenses.
Conclusion
By providing a steady stream of tax-free income, customizable payout options, and protection against the mismanagement of funds, structured settlements offer a secure and reliable foundation for long-term financial stability. However, claimants must also consider disadvantages, such as the lack of flexibility once settlement terms are finalized, the risk of selling payments at a discount, and the impact of inflation on the long-term value of the settlement.
Seek Professional Advice When Incorporating Structured Settlements into Financial Plans
Given the complexity and long-term implications of structured settlements, it is important for claimants to seek professional legal advice and work with their attorney, settlement planner, and financial advisor to assess the suitability of structured settlements in their specific circumstances.
FAQs about Structured Settlements
