Structured settlements have become a natural part of personal injury and workers’ compensation claims in the United States, according to the National Structured Settlement Trade Association (NSSTA). In 2001, NSSTA life insurance members issued more than $6.05 billion in annuities issued as settlement of bodily injury claims. This represents a 19 percent increase from 2000.
A structured settlement is the dispersal of money for a legal claim where all or part of the settlement requires future periodic payments. The money is paid in regular installments (annual, semi-annual or quarterly), either for a fixed period or throughout the life of the claimant. Depending on the needs of the person involved, the structure may also include some immediate payment to cover special damages. Payment is usually made by purchasing an annuity from a Life Insurance Company.
A structured settlement structure can provide long-term financial security to injury victims and their families through a stream of tax-free payments tailored to their needs. Historically, they were first used in Canada and the United States during the 1970s as an alternative to lump sum payments for injured parties. A structured settlement can also be used in situations involving lottery winnings and other substantial funds.
How a structured settlement works
When a plaintiff settles a case for a large sum of money, the defendant, the plaintiff’s attorney, or a financial planner may propose paying the settlement in installments over time instead of a single lump sum.
A structured settlement is actually compensation. Individuals who were injured and/or their parents or guardians work with their attorney and a third-party broker to determine future housing and medical needs. This includes all upcoming operations, therapies, medical devices, and other health care needs. An annuity is then purchased and held by an independent third party who makes payments to the injured person. Unlike stock dividends or bank interest, these structured settlement payments are entirely tax-free. In addition, the individual’s annuity grows tax-free.
Pros and cons
As with anything, there is a positive and negative side to structuring settlements. A significant advantage is tax evasion. When properly established, a structured settlement can significantly reduce the plaintiff’s tax liability (as a result of the settlement). Another benefit is that a structured settlement can help ensure that the plaintiff has the funds to pay for future care or needs. In other words, a structured settlement can help protect the plaintiff from himself.
Let’s face it: Some people have a hard time managing money or saying no to friends and family who want to “share the wealth.” Receiving money in installments can make it last longer.
One drawback to structured settlements is the built-in structure (no pun intended). Some people may feel restricted by periodic payments. For example, they may want to purchase a new house or other expensive item, but lack the funds to do so. They cannot borrow against future payments by virtue of their settlement, so they are stuck until the next installment payment arrives.
And from an investment perspective, a structured settlement may not make the most sense for everyone. Many standard investments can provide a higher long-term return than annuities used in structured settlements. So some people may be better off agreeing to a lump-sum settlement and then investing it themselves.
Here are some other important points to note about structured settlements: An injured person with long-term special needs may benefit from having regular lump sums to purchase medical equipment. Minors may benefit from a structured settlement that provides for certain costs when they are young, such as education expenses, rather than during adulthood.
– Injured parties should beware of potential exploitation or dangers related to structured settlements. They should carefully consider:
– High commissions: Annuities can be very profitable for insurance companies and often carry very high commissions. It’s important to make sure that the fees charged when setting up a structured settlement don’t eat up too much of your principal.
– Inflated value: Sometimes the defense will exaggerate the value of a negotiated structured settlement. As a result, the plaintiff ends up with much less than what was agreed upon. Plaintiffs should compare the fees and commissions charged for similar settlement packages by a variety of insurance companies to ensure they are getting full value.
– Conflict of Interest: There have been situations where the plaintiff’s attorney has referred the client to a particular financial planner to set up a structured settlement, without disclosing that they would receive a referral fee. In other cases, the plaintiff’s attorney has entered into a structured settlement on behalf of a client without disclosing that the annuities are purchased from his own insurance company. Plaintiffs should be aware of what financial interest their attorney may have in connection with any financial services provided or recommended.
– Use of multiple insurance companies: It is advisable to buy annuities for a structured settlement from several different companies. This offers protection in the event that a company that issued annuities for a settlement package goes bankrupt and defaults.
Benefits of Selling a Deal
A structured settlement is specifically designed to meet the needs of the plaintiff at the time it is created. But what if the installment arrangement no longer works for the individual? If you need cash for a large purchase or other expenses, consider selling your structured settlement. Many companies may purchase all or part of your remaining periodic settlement payments for a lump sum. This can increase your cash flow by providing funds you can use immediately to buy a home, pay for college tuition, invest in a business, or pay off debt.
If you are considering cashing in your structured settlement, contact your attorney first. Depending on the state you live in, you may have to go to court to get approval for the buyout. About two-thirds of states have laws that limit the sale of structured settlements, according to the NSSTA. Tax-free structured settlements are also subject to federal restrictions on their sale to a third party, and some insurance companies will not assign or transfer annuities to third parties.
When selling your structure settlement, check with several companies to make sure you get the highest payment. Also, make sure the company you buy your settlement from is reputable and well-established. And keep in mind that if the deal sounds too good to be true, it probably is.