How does a structured settlement work?
Structured settlement payments arise when a personal injury plaintiff wins or settles a lawsuit. The individual takes the winning as a series of payments over some time. As a result, the defendant pays the settlement through an insurance company annuity. The resolution differs from the lump-sum agreement for the way it pays the compensation over time. Please keep reading for How does a structured settlement work.
The plaintiff wins a lawsuit, for instance, because of injury, because of medical malpractice or negligence. It awards a settlement for damages in a series of payments. The annuity company often sets structured settlements to coincide with certain vital ages. For example, an injured child receives a structured compensation designed to have the bulk of the payment at the age of 21. On the other hand, a settlement for an injured 40-years old adult with annual payments for the next 30 years and a lump sum at 70 years. Therefore, each structured settlement is unique.
Also, the settlement avoids the financial risk that may arise with the defendant unable to raise the payment over the years or even decades. In a ruling, the judge directs the defendant through an assignee to purchase an annuity. The periodic payments are guaranteed for the entire period through a professional liability insurance company and an annuity from a quality insurance company.
The insurance company over an annuity makes the obligatory payments to the claimant. It allows the defendant to resolve their end of the settlement with a single lump-sum amount.
Setting up a structured settlement depends on many factors, which includes:
- Your tax liability.
- How you plan to spend the compensation.
- Whether you need professional help in managing the funds?
Below you can learn how a structured settlement works and review some things you should consider when deciding to take a structured settlement if you win or settle your lawsuit.
How Do Structured Settlements Work?
A structured settlement recompenses out money awarded from a legal settlement through periodic annuities to the claimant. In the legal agreement with the plaintiff can receive either a structured compensation or a lump-sum—which provides a one-time sum of money. There is a vast distinction between the two options, which include long-term financial security and tax liability.
For example, the compensation received from a personal injury case enjoys tax exemption when received. But, once the money is yours, you are liable to State and Federal government taxes and dividends from the lump sum settlement. Please keep reading for How does a structured settlement work.
If you agree to take the compensation as a structured settlement rather than one colossal amount, you will receive periodic payments. It disburses structured settlement payments to the Payee over a fixed number of years.
For example, if you win a civil lawsuit, with a structured settlement of $500,000, you might need the defendant to pay an annual installment of $50,000 for the next 10-years. Therefore, the defendant’s insurance company can design a structured settlement that will make annuities for the set time.
The lawsuit judgment can also plan a structured settlement that provides money when the plaintiff is in need.
Here are a few unique options for structured settlement:
A large initial payment
Because of the injuries sustained, you may be out of work for some time, which translates into due bills mounting. You can scheme a structured settlement that provides large payments to cover all the overdue bills as the initial payment. It will help the Payee pay off a mortgage or purchase expensive medical equipment needed for home care. The rest of the settlement is payable in installment/annuities that acts as a substitute for lost income. Please keep reading for How does a structured settlement work.
Additional lump sum for extraordinary expenses
You can have a settlement designed to provide yearly income—particular or additional amount set for extraordinary expenses such as medical emergencies or college tuition. Once in a while, the Payee can request a large payment instead of a periodic payment scheduled.
Payment increases over time
The plan could set the series of payments resulting from a structured settlement to increase over time. Therefore, the amount starts relatively low and stepping up to the end with a higher annuity.
Payment decreases with time.
The structured settlement payments can start with a high amount and decrease over time. Such a settlement will benefit a Payee expecting income to increase over time.
You can delay the settlement payment until you retire if you have an ongoing income at the moment.
Why is not a lump sum always the best option?
There are a few key reasons you should not accept the civil lawsuit settlement proceeds as a lump-sum. Even the judge knows it is not an outstanding idea to allow a lump sum payout. Thus, most of the judgment makes it mandatory for structured settlements. Please keep reading for How does a structured settlement work.
First, you cannot overlook the emotional ordeal, and implications of a trauma experienced from an accident. Besides, after a catastrophic injury or wrongful death of a loved one, the beneficiary finds the added pressure of handling a colossal lump sum of cash overwhelming. Most people, without prior exposure to such an extensive amount of money, cannot hold it together.
Second, a lump sum will jeopardize your benefits eligibility for relevant government-based benefits such as Medicare and SSI. Most of the need-based government benefits use your current assets test to determine your eligibility. For example, a claimant with more than $2000 in countable assets and $3000 will lose eligibility for Medicare and SSI if married.
Third, most of the ordinary investment vehicles, such as stocks and mutual funds, do not guarantee a guaranteed return. However, the Payee structured settlement has a guaranteed return. So, in case of a sudden market downturn, you cannot lose your stream of income. To avoid this, have your settlement in structured payments rather than a lump sum or placed in a traditional investment. Besides, most investments in the open market also come saddled with overhead expenses and enormous fees. Although they vary depending on financing and the institution through which the assets are handled, most eat on your money. It protects a structured settlement from all this by reinsurance.
While the proceeds are not taxable, any growth on that income is subject to an income tax. Even worse for a lump sum payment as you pay the tax right away. Structured settlement differs from charge until the actual amount arrives. You can escape taxation by choosing a better option, such as structured settlement annuities.
Structured Settlement as an Annuity
To actualize the periodic payouts, the wrong party often pays an annuity from a high-end insurance company. Therefore, the defendant can remove your obligation from their books and transfer the payment responsibility to a third party. The transfer ensures continuity of the compensation, even if the defendant ends up bankrupt. Besides, insurance companies responsible for the payments have plenty of expertise in managing periodic payments. So, the defendant or fault party funds the annuity through a one-time payment. Please keep reading for How does a structured settlement work.
As a result, placing the annuity with an insurance company is a more stable alternative. It is better than relying on the stability and financial health of the defendant corporations.
Structured settlements: A tax-free income solution
One of the significant benefits of a structured settlement over the lump-sum is a tax liability. As a result, both the compensation proceeds and interest yield within a structured settlement are 100% income tax-free. Besides, the model guarantees periodic payments, and so the rate of return. Your structured settlement is safe and will remain constant even if the market dives. Also, the proceeds do not incur overhead fees, and the plan is flexible in design. You can opt for monthly, bi-annual, or annual periodic annuities. Please keep reading for How does a structured settlement work.
The plan can include a series of a few more enormous lump sums in case of more considerable future expenses such as college tuition or home improvement. Any cost expected can be worked into the schedule, as the prime aim of the settlement is to meet the plaintiff’s needs.
If you combine the lack of charges and the tax-free growth, a structured settlement outperforms any other form of compensation. What better way for a plaintiff to maximize their settlement proceeds than in a structured settlement? You cannot get an investment offering such guaranteed long-term financial security.
Tax obligation for structured settlement
What Is Your Tax Obligation? Think of it; whether the award is taxable or tax-free depends on whether it intends to compensate for physical injuries or sickness. Are the damages, punitive? Such a situation warranties taxation when the compensation plans to punish the defendant for their actions. Find out more about costs in personal injury cases in our previous post.
The plan of payment—periodic payments or lump-sum—affects your tax obligation. Consult with a tax attorney or tax professional at any stage to avoid unnecessary taxation. You will find out the state and Federal laws complicate the tax scenario in a structured settlement.
Structured Settlements Pros and Cons
A structured settlement provides many benefits, not the least, and it guarantees the Payee future income. As you accept a structured settlement, it is paramount you consider the advantages and drawbacks of your unique circumstance. Also, consider the tax implication and your need for liquidity. Besides, a structured settlement principal goal is to provide the plaintiff with the best financial support.
At all costs, you need guidance on every aspect of the structured settlement, consultation with your attorney, and a trusted financial advisor.
Benefits of structured settlement
- The payouts, including interest earned over time, are tax-free.
- Structured settlement payments do not affect Medicaid, social security disability benefits, or other forms of aid eligibility.
- In the event of the premature death, periodic payments move to the next kin with all the benefits and attributes.
- Structured settlement payment design and schedule fall under the discretion of the plaintiff.
- Spread out payment over time, reduces the temptation to make significant and extravagant purchases as it guaranteed future incomes. Best for a medical condition that needs long-term care.
- Structured settlement does not suffer any financial markets for fluctuations.
- They re-insure the payments with state insurance guaranty association and top insurance companies.
- Structured settlement annuity often yields in total, more than a lump-sum payout you would receive in a lump-sum. Annuity attracts high interest over time.
Structured settlement terms are final once signed offer. There is little you can do to alter them. But in exceptional cases, you can renegotiate the terms through a judge.
In case of an emergency, you cannot access the funds immediately. You cannot leverage an opportunity for investment. The full amount earns top rates of returns.
Tapping into the structured settlement benefits of selling the payments cost a lot. The holding company asks for surrender charges coupled with IRS penalties for early withdraw. The opportunity to remove the amounts comes at the age of 59½.
The government can tax some payable expenses such as lawyer charges and punitive damages. Also, not all insurance companies disclose their fees in establishing the payments. Without such information, you lose a significant amount of money through administrative fees.
With the help of an attorney and financial advisor, you can decide the best form of a structured settlement that matches your financial goals and needs. Besides, you cannot negotiate the terms of the agreement without the help of an experienced individual—you all the help you can find in determining the structure of your award of compensation. Also, you need to maximize your outcomes based on your current and future circumstances and achieve your financial goals.
Start by asking yourself how you will use the settlement money. Do you need cash low right now for your due bills? Are you using the settlement to replace future income? Your goals for money have an enormous impact on how best to structure the compensation. You also need to learn how to manage a substantial award.
- 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
- 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
- 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