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What Is a Structured Settlement?
Structured settlements are simple. Many civil lawsuits result in someone or some company paying money to another to right a wrong. Those responsible for the wrong may agree to the settlement on their own, or they may be forced to pay the money when they lose the case in court.
If the amount of money is small enough, the wronged party may have the option to receive a lump sum settlement. For larger sums, however, a structured settlement annuity may be arranged.
In this case, the at-fault party puts the money toward an annuity, which is a financial product that guarantees regular payments over time from an insurance company.
The agreement details the series of payments the person who was wronged will receive as compensation for the harm done to them. Spreading the money over a longer period of time offers a better future guarantee of financial security because a single payout can be spent quickly.
History of Structured Settlements in the U.S.
The U.S. has a rich history of structured settlements, but that wasn’t always true. Modern adoption of these payments can be traced back to Canada in the 1960s when a medication called thalidomide caused birth defects in thousands of children. Rather than receive a one-time payment from the at-fault pharmaceutical company, the claimants needed a series of payments over a longer timespan to cover future medical bills.
Structured settlements were first issued in the U.S. in the 1970s when similar cases arose. In that decade, the IRS Revenue Ruling 79-220 that was issued in 1979 provided tax benefits for the recipient, citing, “The taxpayer’s only right with respect to the amount invested was to receive the monthly payments, and the ruling concluded that the taxpayer did not have actual or constructive receipt or economic benefit of the amount invested.”
Settlement payments to the injured party did not count towards their gross income, and thus they were not required to pay taxes on any money received. Likewise, after the recipient passed away, payments to the estate continue to be excluded from taxation.
Structured settlements gained popularity in the 1980s after the U.S. Congress passed the Periodic Payment Settlement Act of 1982. The act served as the federal government’s buy-in with the IRS ruling and extended restrictions to the state governments, barring them from taxing structured settlement income from personal injury cases.
By 1985, the National Structured Settlements Trade Association formed to preserve and promote structured settlements to injury claimants through education and advocacy.
Over a decade later, the Small Business Job Protection Act of 1996 set limitations on the types of personal damage cases eligible to receive the tax benefits. As a result of this act, only damages from “personal physical injuries or physical sickness” can exclude payments from gross income. Payments from punitive damages were no longer eligible for tax exclusions.
Today, structured settlements remain a trusted source of financial security, with an estimated $10 billion annual payments issued to over 30,000 recipients. Now, it’s become commonplace for the claimants to choose a preference for periodic payments, a one-time lump-sum payout, or a blend of both.
How Do Structured Settlements Work?
Legal settlements can be paid out in a one-time lump sum or through a structured settlement where periodic payments are made through a financial product known as an annuity. The key differences between these settlement options are in the areas of long-term financial security and taxes.
When a plaintiff receives a settlement through a one-time lump sum, they might spend it too quickly, robbing them of the long-term financial security that future payments could provide.
Moreover, any interest and dividends earned if the lump-sum were to be invested would be subject to taxes. Conversely, an annuity is meant to provide income throughout the recipient’s lifetime, and any interest and taxes earned through the annuity will grow tax-free.
Types of Structured Settlement Cases
There are a number of reasons why an individual may receive a structured settlement.The most common cases include:
- Personal Injury
- A personal injury case is a civil case where someone who’s been harmed files a lawsuit seeking money from the person believed responsible for the harm. Money in the form of a structured settlement helps recipients pay for medical expenses or other costs.
- Workers’ Compensation
- Most people know about workers’ compensation, which pays workers who get injured on the job while they recover. Payments can be used as wage replacement or to pay for medical treatment and other expenses during periods when injured employees are unable to work.
- Medical Malpractice
- In some unfortunate cases, doctors can do more harm than good. In this instance, injured patients or the families of deceased patients can sue for medical malpractice.
- Wrongful Death
- A structured settlement is also a common way to compensate family members who claim loved ones were victims of wrongful deaths. Families may be entitled to receive a stream of tax-free payments to replace income after a loved one’s death.
Structured settlements — or structured annuities — are both financial products and legal judgments. While they function somewhat like private assets, they are also subject to complex regulations.
Legal Structure: Assigned vs. Unassigned Cases
An assigned case is a qualified case, meaning the settlement proceeds qualify for tax benefits, and the defendant’s payment obligation must align with Internal Revenue Code provisions. In assigned cases, a third-party assignment company collects the funds from the defendant, and then purchases the annuity from a different insurance company. That annuity will fund the periodic payments directly to the claimant. The claimant, or plaintiff, does not control the annuity contract.
Conversely, in an unassigned case, the defendant is a property and casualty insurance company that purchases the annuity from a separate life insurance company. The defendant technically owns the annuity, and they name the injured party as the payee.
- Structured Settlement Payout Options
- Compare and contrast the different ways to accept a cash settlement from a lawsuit.
- Government Support for Structured Settlements
- Learn about how the government uses the tax code to promote their use.
- Structured Settlements for Minors
- Read about why this type of settlement is typically used in cases involving children.
Payout Options for Structured Settlements
If you elect to receive your lawsuit payout through a structured settlement, you can determine whether to begin to receive the funds immediately or at a later date. Immediate payments can be beneficial if you require medical care, for example, or have lost your source of income. You may decide to postpone the payments until a later time, such as after you retire. During the waiting period, the annuity will grow as it earns interest.
You can also determine whether the annuity should be paid for the rest of your life, no matter how long that may be, or for a specified number of years, as well as the schedule for receiving payments and the payment amounts and adjustments.
Often, plaintiffs will need money for a variety of expenses before they receive their settlement. If you find your expenses mounting as you await your first structured settlement payment or initial lump sum, you may want to consider pre-settlement funding options to tide you over.
Structured Settlement Pros and Cons
Structured annuities are ideally suited for many different types of cases. Although these scheduled payments offer several advantages, it is important to understand the benefits along with the risks when deciding on any financial investment.
- Payments are tax-free.
- In the event of the recipient’s death, the beneficiary can continue to receive tax-free payments.
- Payments can be scheduled for almost any length of time and can begin immediately or be deferred for as many years as requested. They can include future lump-sum payouts or benefit increases.
- Spreading out payments over time can reduce the temptation to make large, extravagant purchases and guarantees future income. This is especially helpful if the recipient has a medical condition that will require long-term care.
- Unlike stocks, bonds and mutual funds, structured settlements do not fluctuate with market changes. Payments are guaranteed by the insurance company that issued the annuity.
- A structured settlement often yields, in total, more than a lump-sum payout would because of the interest your annuity may earn over time.
- Once terms are finalized, there’s little you can do to alter them if they do not meet your needs. You cannot renegotiate the terms if your financial situation or the overall economy changes.
- Funds are not immediately accessible in case of an emergency, and the recipient cannot place a lump-sum payout in other investments that carry higher rates of return.
- You can sell your payments if you need immediate cash, but these payments will be sold at a discount. This means the cash amount you receive from selling the payments will be less than the amount you would have ultimately received from future payments.
- You will pay surrender charges and IRS penalties if you withdraw funds before age 59½.
- Not all states require insurance companies to disclose their costs to establish a structured settlement or lump-sum annuity. Without this information, a recipient could lose a significant amount of money through administrative fees.
Options for Annuity Owners to Sell Payments
You should carefully consider the terms of your annuity because they can’t be renegotiated after the contract has been issued. That can limit your options if your financial situation changes due to unemployment, illness or other setbacks.
However, annuity owners may have the option to get cash in advance of their contract schedules. Owners may sell some or all payments to structured settlement buyers. Some buyers may inaccurately refer to these sales as “structured settlement loans.” In reality, they are actually purchasing your settlement, which will effectively halt your regular payments. Such sales must be approved by a judge. The role of the judge is to decide if the sale is in the best interest of the annuity owner.
Other rules may apply depending on the details of your annuity contract and the laws of the state where you live. The Structured Settlement Protection Act of 2002 provides federal guidelines on such transactions.
Annuity owners should carefully consider their options before selling payments. You can learn more at Selling Structured Settlement Payments, and download our free step-by-step Guide to Selling Your Structured Settlement Payments.
- The secondary annuity market
- Key considerations and requirements
- Selling payments for minors
Frequently Asked Questions About Structured Settlements
10 Cited Research Articles
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- Bollman, K. (2018, May 7). Structured Settlements: Then And Now. Retrieved from https://www.forbes.com/sites/impactpartners/2018/05/07/structured-settlements-then-and-now/?sh=4c8c10f71361
- Fazio, W. B. (2010, June 7). Structured settlements 101. Retrieved from https://www.lexisnexis.com/LegalNewsRoom/workers-compensation/b/workers-compensation-law-blog/posts/structured-settlements-101
- National Structured Settlements Trade Association (n.d.). Structured Settlements Give You Peace of Mind. Retrieved from https://www.nssta.com/
- Prudential Structured Settlements. (n.d.). Structured Settlements: Helping claimants and their families achieve financial security. Retrieved from https://www.nssta.com/sites/default/files/library/2018/2018-03/Prudential%20White%20Paper.pdf
- Surana, R. (2016, February 25). Pros and cons of structured settlement annuities. Retrieved
- from https://www.law360.com/articles/763833/pros-and-cons-of-structured-settlement-annuities
- U.S. 97th Congress. (1982, July 12). Hearings before the Subcommittee on Select Revenue Measures. Retrieved from https://www.google.com/books/edition/Miscellaneous_Tax_Legislation/vfssAAAAMAAJ?hl=en&gbpv=1&dq=rev.%20rul.%2079-220
- U.S. 104th Congress. (1996, August 20). Small Business Job Protection Act of 1996. Retrieved from https://www.govinfo.gov/content/pkg/PLAW-104publ188/pdf/PLAW-104publ188.pdf
- U.S. Senate Committee on Finance. (1982, October 1). Periodic Payment Settlement Act of 1982. Retrieved from https://www.finance.senate.gov/imo/media/doc/srpt97-6461.pdf
- Wood, R. W. (2010, October 26). What's a 'structured settlement'? Retrieved from https://www.forbes.com/sites/robertwood/2010/10/26/whats-a-structured-settlement/#151438c44422