Structured Settlements

A structured settlement pays out money owed from a legal settlement through periodic payments in the form of a financial product known as an annuity. Money from a personal injury or medical malpractice case gets distributed over a longer period to provide for long term needs.

When those needs change, the contract typically cannot be changed. However, those receiving settlement payments can choose to sell future payments in exchange for a lump sum.

Structured Settlements Explained

Legal language aside, structured settlements are simple. In a civil case, someone is either forced or agrees to pay someone else money to right a wrong. Instead just writing a check, the at-fault person outs the money towards an annuity from a life insurance company. In that annuity contract are details on the series payments the person who was wronged will receive from the life insurance company.

By structuring the money over a longer period of time, a structured settlement offers a better future guarantee of money than a single payout which can be spent quickly.

The process is around 40 years old. In the 1970s, the courts ruled that a medication called Thalidomide given to pregnant women was responsible for serious, lifelong birth defects, structured settlements emerged as a way to make sure the money awarded to the child lasted a lifetime.

Still, today, most settlements from civil cases are lump sums. There are two key differences between lump sum settlements and structured settlements: long term security and taxes. By structuring the money over a longer period of time, a structured settlement offers a better future guarantee of money than a single payout which can be spent quickly. Money you receive from a personal injury is almost always tax free when you receive it. However, once the money is yours, you’re liable for taxes and dividends from the lump sum.

Why People Receive Structured Settlements

STRUCTURED SETTLEMENTS
A structured settlement is a type of annuity that pays out an awards from civil lawsuits.

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 recipient pay for medical expenses or other costs.

Wrongful Death

A structured settlement is also a common way to compensate the family of someone whose death was the subject of a wrongful death claim. Families may be entitled to receive a stream of tax free payments, to replace the loss of income previously earned by the lost loved one.

Worker’s Compensation

Most people know about workers compensation, which pays out workers who get injured on the job while they recover. Payments can be used for medical treatment and wage replacement during periods when injured employees are unable to work and other expenses.

Structured Settlement Options

Structured settlement recipients have several options to choose from when determining how to receive their award. Structured settlement options include receiving:

  • The entire amount in equal payments over a period of time, also called Time Certain.
  • The entire amount in unequal payments over the period of the Term Certain agreement. For example, the payments may increase or decrease in amount over time.
  • Payments until the recipient dies, also called Life Only.
  • The entire amount in payments until the recipient’s death, at which point a beneficiary will become the new recipient of payments until the term of the agreement has ended.
  • A lump sum payment after the annuity is awarded, or at a later date, such as with a deferred annuity.
  • A lump sum initially for a part of the total amount, followed by recurring payments until the end of the term.
  • Delayed payments that may begin at a certain date or age, such as when the recipient enters retirement.

 

Pros & Cons to Structured Settlements

Structured settlements are ideally suited for many different types of cases. However, once the terms are in place, they cannot be changed. Because of these inflexible contracts, some recipients choose to sell their payments for a lump-sum payout.

Pros

  • Structured settlement payments are tax-free.
  • In the event of the recipient’s premature death, the contract’s designated heir can continue to receive any future guaranteed 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 are not dependent on fluctuations of financial markets. 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.

Cons

  • 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 recipient cannot invest the lump-sum payout in other investments that carry higher rates of return.
  • Tapping into your structured settlement without selling payments will cost you money. You will pay surrender charges and IRS penalties if you withdraw funds before age 59½.
  • Some parts of a settlement, such as attorney’s fees and punitive damages can be taxed.
  • 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 from their settlement through administrative fees.

Choosing Between Lump Sum and Structured Settlements

Just as there are positives and negatives to electing a structured settlement, there are also pros and cons to electing a lump sum payment. This decision will have long-lasting personal and tax consequences, and should be made under the advisement of a professional such as an accountant or attorney.

When deciding between a lump sum and structured settlement, you should consider factors like:

  • Tax obligations
  • Planned large expenses such as mortgage or tuition payments
  • How risky your spending habits are
  • Expectations of financial assistance from family or friends
  • Your financial skills and know-how to manage the full award responsibly

Taxes Decoded: Qualified vs. Unqualified

Structured settlements are often divided into two categories: qualified for tax exemption and unqualified for tax exemption.

Exceptions can exist however, so consult a financial professional when preparing your state and federal taxes.

Qualified Structured Settlements

Qualified

The traditional structured settlement for physical injury or sickness claims must meet certain requirements in order to qualify for tax exemption. These requirements include: the settlement amount has to be placed in an annuity, periodic payments are fixed and determinable as to amount and time of payment, claimant cannot modify the periodic payments, and those payments must be payable to the recipient or liability insurer.

Unqualified

This type of settlement is used when claims for damages fall outside the usual scope of physical injury, sickness or wrongful death and thus are not tax exempt. They are often used for claims involving racial discrimination, sexual harassment, wrongful termination, or violation of the Americans with Disabilities Act of 1990 or the Employee Retirement Income and Securities Act of 1974. The tax benefits differ among the types of transactions.

Qualified Structured Settlements

Structured Settlements and Divorce

When dividing assets in a divorce, structured settlements can subject to being split between the two spouses.

Typically the spouse who doesn’t keep the settlement will get a different asset to balance out the overall division of assets.

How a settlement is handled in a divorce depends on the approach your state takes in asset division. States either divide assets according to community property or by equitable division.

According to community property, anything owned by either spouse before and during the marriage is considered property of the union and can be subject to division. If you live in a state with equitable distribution and you had the settlement before you were married it is likely you will keep the settlement.

In any state, the division of assets doesn’t mean the settlement check itself gets divided. Typically the spouse who doesn’t keep the settlement will get a different asset to balance out the overall division of assets. If you have a settlement and are facing divorce, you may want to hire a lawyer or mediator with experience handling complex assets.

Inheriting a Structured Settlement

The details of your annuity contract should indicate if you are able to designate an heir in the event of your death. The contract should indicate if your payments are are what’s called “guaranteed payments” or if they are “life contingent payments.”

Guaranteed Payments

These are payments which are paid per the contract no matter what. If the person who was awarded the settlement passes away, they can designate an heir to receive those payment instead.

Life Contingent Payments

Considered non-guaranteed, these payments are contingent on the person with the settlement being alive. If the person receiving the payment passes away, the insurance company does not send future payments to an heir.

Rights to Sell Structured Settlements

Structured settlement terms are unable to be renegotiated once the annuity contract has been issued. For some, this means not being able to access their money when they need it.

The structured settlement secondary market emerged because people wanted a way to sell future payments for a lump sum today.

However, for those who have a financial need, there is a way to access their funds by selling payments. The structured settlement secondary market emerged because people wanted a way to sell future payments for a lump sum today. So companies now exist which buy structured settlements in exchange for cash now.

As with any major financial decision, the choice to sell should be something you carefully consider. Federal and state regulations requires the sale of structured settlement payments to go through a judge to ensure it’s in the best interest of the person selling.

Best Structured Settlement Buyers

Selling your structured settlement payments is possible and perfectly legal. Unfortunately unscrupulous companies may try to prey on the financial need of those looking to sell.

Signs of a bad structured settlement buyer:

  • Misleading behavior, for instance says one thing but puts another thing in writing
  • Rushes you to sign something you don’t understand
  • Asking you to lie or misrepresent yourself on a form

Signs of a good structured settlement buyer:

  • Gives you personalized service with a real person, not an automated telephone system
  • Takes the time to make sure you understand the selling process
  • Gives you time to examine the contract

Laws Affecting Structured Settlements

1

Periodic Payment Act

President Ronald Reagan signed the act in 1982, providing the use of structured settlements to seriously injured victims and their families for long-term, tax-free financial security.

2

Federal Protection

Enacted shortly after victims of the 9/11 disaster started receiving financial awards as compensation, it mandated a court appearance when selling structured settlement payments.

3

Legislative Safeguards

Most states have has laws regulating the sale of structured settlement payments. Many ensure sellers receive counseling and instruction before selling their payments.

The Court Process of Structured Settlements

Both the awarding and selling of structured settlements involves a court process.

A:The Defendant uses a structured settlement to give money to the plaintiff while not being liable long term.

B:The defendant works with a qualified assignee to determine the terms of the structured settlements.

C:The qualified assignee works with a life insurance company to purchase an annuity which matches the settlement needs.

D:Then the life insurance company pays the plaintiff a series of payments over time.

Selling Structured Settlements Flow Chart

Structured Settlement Minors

Structured settlements have become popular in accident or personal injury lawsuits involving children.

In the past, many adults acting as parents or guardians of injured children had unlimited discretionary use of a minor’s settlement funds. They spent the money irresponsibly on purchases unrelated to their court-prescribed purposes.

Timed payouts were developed as an alternative to ensure that minors had money for essential long-term necessities, like food, clothing and shelter, and for any continuing medical care.

The process for selling the structured settlements of minors is highly regulated, and these payments are not often approved for transfer.

Because of the danger of parents inappropriately using settlement funds, the process for selling the structured settlements of minors is highly regulated, and these payments are not often approved for transfer.

Read more about Structured Settlements & Minors

Page Sources

  1. Already Have a Structure? (ND). Retrieved April 18, 2016, from http://www.nssta.com/structured-settlements/already-have-structure
  2. Internal Revenue Code (ND). Structured Settlement Factoring Transactions. Retrieved from http://www.gpo.gov/fdsys/pkg/USCODE-2011-title26/pdf/USCODE-2011-title26-subtitleE-chap55.pdf
  3. Benefits of the Secondary Market. (n.d.). Retrieved April 18, 2016, from https://nasp-usa.com/settlement-transfers/secondary-market-benefits/
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