Structured Settlements

Structured settlements pay compensation to victims of injury, death due to negligence, or workers’ compensation claims. A structured settlement is a stream of tax-free payments paid over time rather than in a lump sum. Payments from structured settlements can be received immediately or earn interest by receiving them later.

What Is a Structured Settlement?

Structured settlements are simple. Many civil lawsuits end with someone or some company paying money to another person to correct a mistake that was made. Those responsible for the wrong may agree to a settlement themselves, or they may be forced to pay money if they lose their case in court.

A structured settlement is a regular stream of tax-free payments given to a plaintiff in a civil lawsuit. Structured settlements are designed to provide long-term financial security for the injured party.}

If the amount is small enough, the injured party may be able to receive a lump sum payment. However, for larger amounts, a structured annuity can be arranged.

In this case, the at-fault party invests in an annuity, which is a financial product that guarantees regular payments over a period of time from an insurance company.

The contract details a series of payments that the at-fault party will receive as compensation for their injuries. Spreading the money out over a longer period of time provides a greater guarantee of financial security in the future because a one-time payment can be spent quickly.

History of Structured Settlements in the U.S.

The United States has a rich history of structured settlements, but this was not always the case. The modern implementation of these payments can be traced to Canada in the 1960s, when a drug called thalidomide caused birth defects in thousands of children. Instead of receiving a one-time payment from the guilty drug company, plaintiffs needed a series of payments over a long period of time to cover future medical bills.

Structured settlements first appeared in the U.S. in the 1970s, when similar cases surfaced. In that decade, IRS Revenue Ruling 79-220 was issued in 1979 that provided a tax break for the recipient, citing that “the taxpayer’s only right with respect to the amount invested was to receive monthly payments, and the ruling states that the taxpayer had no actual or constructive gain or economic benefit from the amount invested.”

The settlement payments to the victim were not included in her gross income, so she did not have to pay taxes on the money she received. Similarly, after the death of the beneficiary, inheritance payments are still excluded from taxation.

Structured settlements became popular in the 1980s after the U.S. Congress passed the Periodic Payment Settlement Act of 1982. This act served to support the federal government against the IRS ruling and extended restrictions to state governments, prohibiting them from taxing income from structured settlements in personal injury cases.

In 1985, the National Structured Settlement Trade Association was formed to protect and promote structured settlements for accident victims through education and advocacy.

More than a decade later, the Small Business Workplace Protection Act of 1996 placed restrictions on the types of personal injury cases that qualify for tax credits. As a result of this act, only payments for “bodily injury or physical illness” can be excluded from gross income. Payments for punitive damages are no longer tax-exempt.

Today, structured settlements remain a reliable source of financial security, with an estimated annual payout of $10 billion to more than 30,000 beneficiaries. It has now become common for claimants to choose interim payments, lump sum payments, or a combination of both.

How Do Structured Settlements Work?

Court settlements can be paid in a lump sum or as part of a structured settlement in which periodic payments are made through a financial product called an annuity. The main differences between these settlement options lie in the areas of long-term financial security and taxes.

When a plaintiff receives a lump sum, he or she may spend it too quickly, depriving himself or herself of the long-term financial security that future distributions could provide.

Furthermore, any interest or dividends received while investing the lump sum will be taxed. In contrast, an annuity is designed to provide income for the life of the recipient, and any interest and taxes earned by the annuity will grow tax-free.

Types of Structured Settlements

There are many reasons why a person may receive a structured settlement. Some of the most common cases include:

Personal Injury

A personal injury case is a civil case in which the injured person sues to recover money from the person believed to be responsible for the injury. The money in the form of a structured settlement helps the recipient pay for medical expenses or other costs.

Workers’ Compensation

Most people know about workers’ compensation, which is paid to employees who are injured on the job while recovering. The payments can be used as wage replacement or to cover medical and other expenses during periods when injured workers are unable to work.

Medical Negligence

In some unfortunate cases, doctors can do more harm than good. When this happens, injured patients or the families of deceased patients can file a medical negligence lawsuit.

Wrongful death

A structured settlement is also a common way to compensate family members who claim that their loved ones were victims of wrongful death. Families may be entitled to a stream of tax-free payments to replace income after the death of a loved one.

Structured settlements – or structured annuities – are both financial products and legal arrangements. While they resemble private assets to some extent, they are also subject to complex regulation.

Legal Structure: Assigned vs. Unassigned Cases

The assigned case is a qualified case, which means that the settlement proceeds qualify for tax benefits and the defendant’s payment obligations must comply with the Internal Revenue Code. In assigned cases, a third-party company collects funds from the defendant and then buys an annuity from another insurance company. This annuity will fund periodic payments directly to the plaintiff. The plaintiff, or claimant, has no control over the annuity contract.

In contrast, 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 enters the injured party as the payor.

Payout Options for Structured Settlements

If you choose to receive a structured settlement, you can choose whether the funds will be withdrawn immediately or later. An immediate payment may be beneficial if, for example, you need medical treatment or have lost a source of income. You can defer payments until later, such as when you retire. During the waiting period, the annuity will grow with interest.

You can also specify whether the annuity will be paid for the rest of your life, regardless of its length, or for a certain number of years, as well as the schedule for receiving payments and the amounts and how they will be adjusted.

Often, plaintiffs need money for various expenses before receiving compensation. If costs are rising as they wait for the first payment from a structured settlement or initial lump sum, consider pre-settlement funding options to address them.

Structured Settlement Pros and Cons

Structured annuities are an ideal solution in a variety of cases. While these scheduled payments offer a number of benefits, it is important to understand the benefits and risks when deciding on any financial investment.

Pros of Structured Settlements

  1. The distributions are tax-free.
  2. If the beneficiary dies, he or she may continue to receive tax-free distributions.
  3. Withdrawals can be scheduled for almost any length of time and can begin immediately or be deferred for any number of years. They may include future lump sum payments or benefit increases.
  4. Spreading out payments over time can reduce the temptation to make large, extravagant purchases and guarantee future income. This is especially useful if the recipient has a health condition that will require long-term care.
  5. Unlike stocks, bonds and mutual funds, structured payouts do not fluctuate with market changes. The payouts are guaranteed by the insurance company that issued the annuity.
  6. Because of the interest that an annuity can earn over time, annuities often provide a higher total return than a single payout.

Cons of Structured Settlements

  1. Once the terms are finalized, there is little you can do to change them if they do not meet your needs. You will not be able to revise the terms if your financial situation or general economic circumstances change.
  2. Funds cannot be immediately available for emergencies, and the recipient cannot invest the one-time withdrawal in other investments that produce higher returns.
  3. You can sell your withdrawals if you urgently need cash, but those withdrawals will be sold at a discount. This means that the amount of money you get from selling your withdrawals will be less than the amount you end up getting from future withdrawals.
  4. Not all states require insurance companies to disclose the costs they incur in creating a structured settlement or lump sum annuity. Without this information, the recipient could lose a significant amount of money due to administrative fees.

Options for Annuity Owners to Sell Payments

Annuity terms must be carefully considered because they cannot be renegotiated once the contract is signed. This can limit your options if your financial situation changes due to unemployment, illness, or other problems.

However, annuity owners can receive cash before the contract expires. Owners can sell some or all of the payments to buyers of structured settlements. Some buyers may mistakenly refer to these sales as “structured loans.” In reality, they are buying your settlement, which effectively terminates your regular payments. Such sales must be approved by a judge. The judge’s role is to decide whether the sale is in the best interest of the annuity owner.

Depending on the details of your annuity agreement and the law of the state in which you reside, other rules may apply. The Structured Settlement Protection Act of 2002 sets federal rules for such transactions.

Annuity holders should carefully consider their options before selling payments. For more information, visit Selling Structured Payments and download our free step-by-step guide to selling structured annuities.

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