How Do Structured Settlements Work?

Explore the topics in this section to gain a full understanding of the different forms structured settlements can take and the reasoning behind them.

Being Awarded a Structured Settlement

The process of settling a civil case through a structured settlement involves the person who has been wronged (the plaintiff), the person or company who caused the harm (the defendant), a consultant experienced in such cases (a qualified assignee) and a life insurance company.

  1. The plaintiff sues the defendant to seek compensation for an injury, illness or death the defendant caused. Often the defendant agrees to give money to the plaintiff through a structured settlement in order to keep the lawsuit from going to trial. If the case does go to trial and the judge rules in the plaintiff’s favor, the defendant may then be forced to set up a settlement.
  2. The defendant and the plaintiff work with a qualified assignee to determine the terms of the structured settlement agreement — that is, how much the regular payments should be, how long they should continue for, whether they should increase or be supplemented by larger payouts at certain times, and so on. The defendant provides money for the qualified assignee to buy an annuity for the plaintiff.
  3. The qualified assignee purchases an annuity from a life insurance company, setting up the annuity contract to match the settlement needs. Once the terms of the annuity are set, they cannot be changed. An immediate lump sum may also be set aside to cover attorney fees or to fund a specified trust.
  4. The life insurance company pays the plaintiff a series of payments over time, according to the terms of the annuity contract. The annuity earns interest to protect its value from inflation, and the only way for the plaintiff to get cash from the settlement ahead of schedule is to sell the right to future payments on the secondary market.

Calculating the structured settlement amount can be a complex financial task. A financial advisor or lawyer will typically hire an economist to help calculate the value of the contract.

Structured Settlements Pros and Cons

Pros:

  • Structured settlement payments do not count as income for tax purposes, even when the structured settlement earns interest over time.
  • Income from structured settlement payments also does not affect your eligibility for Medicaid, Social Security Disability benefits or other forms of aid.
  • In the event of the recipient’s premature death, the contract’s designated heir can continue to receive any future guaranteed payments, tax-free.
  • 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 scheduled lump-sum payouts or benefit increases in anticipation of future expenses.
  • Spreading out payments over time can reduce the temptation to make large, extravagant purchases, and it guarantees future income. This is especially helpful if you have a medical condition that will require long-term care.
  • Unlike stocks, bonds and mutual funds, fluctuations in financial markets do not affect structured settlements.
  • The insurance company that issued the annuity guarantees payments. Even in the unlikely event that the insurance company becomes insolvent, your state’s insurance guaranty association still protects you from loss.
  • A structured settlement annuity contract often yields, in total, more than a lump-sum payout would because of the interest the annuity may earn over time.

Cons:

  • Once the terms of a settlement 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 you don’t have the opportunity to use the full amount of the settlement for investments that carry higher rates of return.
  • Tapping into your structured settlement benefits 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 fees for establishing a structured settlement or lump-sum annuity. Without this information, you could lose a significant amount of money from your settlement through administrative fees.

Understanding Structured Settlement Annuity Contracts

Structured settlement agreements are designed to provide periodic payments over a fixed number of years. However, the plaintiff can decide how the money is distributed and how much is provided yearly. Structured settlement benefits can be delayed until retirement, or awarded through a large lump sum payment, with complementary smaller payments over time in order to pay bills or relieve debt. Benefits can also act as an additional yearly income stream, with payments increasing or decreasing through the agreement term. These types of settlements have become more common over the years because of the advantages they offer to individuals and their families.

Lawsuit Payout Options: Lump sum settlements come with the most freedom and the most risk. Structured settlements, on the other hand, are flexible to set up but rigid once awarded.

  • Lump Sum Settlement Considerations
  • The Flexibility of Structured Settlements
  • Start and End Dates
  • Payment Frequency and Amount

Government Support for Structured Settlements: Thanks to the Periodic Payment Settlement Act of 1982, many annuities awarded through lawsuits are exempt from income taxes.

  • Ensuring Money for the Long Term
  • The Pitfalls of Lump-Sum Settlements
  • Qualified Versus Unqualified Settlements
  • The Tax-Free Status of Qualified Structured Settlements

Structured Settlements for Minors: Structured settlements are considered ideal for ensuring that an underage child’s cash settlement is preserved and spent appropriately.

  • Ensuring Money for a Child’s Future
  • How Minors Benefit from Structured Settlement Agreements
  • Designing a Minor’s Structured Settlement
  • Structured Settlements Versus 529 Plans
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