What is a structured settlement?
A structured settlement is when you get court-ordered compensation as a plaintiff in a civil lawsuit. Usually, these cases revolve around personal injury, wrongful death, medical malpractice, and other issues. The money is paid by an insurance company through an annuity purchased on behalf of the recipient (which is you).
People choose structured settlements instead of a lump sum because of the tax advantage. While you forego immediate cash, these periodic payments are designed to provide long-term financial security and protection against market fluctuations.
However, financial obligations such as high-interest debt, mortgage payments, or medical bills may arise. When there’s an emergency at hand, some people are ready to sell some or all their future payments in order to get cash fast now.
Advantages and Disadvantage of Cashing out Structured Settlements
Wondering about the pros of selling your structured settlement instead of waiting for a payment stream over time? Here are some common benefits people experience when they cash in.
- Handle a major change in financial situation: Getting a lump sum of cash can help you out of an emergency. Maybe you lost your job or need to cover medical expenses for yourself or a loved one. Having an influx of money could help.
- Avoid expensive funding options: Selling your structured settlement lets you avoid borrowing money at a high interest rate.
- Pay off high-interest debt: Existing high-interest debt can make it tough to keep up with payments and save for the future. You may consider selling part or all your annuity in order to tackle those balances.
There are also drawbacks to consider before you decide to sell your structured settlement.
- Long processing time: From start to finish, expect the process to take one to three months. The bulk of this time is spent waiting on court approval for the sale of your annuity to make sure the transaction is in your best interest.
- Lower payout amount: You don’t receive the total balance of your remaining structured settlement. Some money is lost due to the discount rate, which is charged by the purchasing company.
- Decreased long-term financial security: Without your full stream of payments ahead of you, you may feel a financial pinch in the years ahead. You should feel confident in your other income streams before you sell any of your settlement payments.
What’s the discount rate?
Cashing out a structured settlement is not free. Factoring companies buy future payments at a discount rate, which means you do not get paid the full amount. The discount rate ranges from 6% to 19% of your annuity value but can be even higher.
Factors that influence the percent of your discount rate are primarily the buyer’s expectation of future interest rates, as well as when payments are due, the number of payments being sold, the dollar amount of those payments, and the insurance company. Bear in mind that different companies will give different offers, so always shop around.
Example of a Discount Rate
Let’s say you have a structured settlement that pays $20,000 per year for a period of 10 years. After five years you need some cash up front and want to cash in some (but not all) of those upcoming payments.
You contact a factoring company to sell payments for years 6 and 7 — a total of $40,000. The offer comes with a discount rate of 12%, which means you receive 88% of the upcoming payments. In this case, that comes to $35,200 instead of $40,000. There may also be some administrative fees that could lower the total amount you receive.
Once year 8 arrives, you start receiving the payments again as previously scheduled.
How to Cash Out Your Structured Settlement?
- Contact multiple factoring companies to compare multiple quotes
- Choose a credible buyer with the lowest discount rate
- Complete paperwork and get court approval
- Receive cash once approved
Structured Settlement Cash Out Options
If you decide to cash out your settlement, it’s important to know that you don’t have to sell all your payments. Instead, you can choose to sell a certain number of payments, or a portion of your future payments. People prefer these options because they get a lump sum and continue to receive future payments.
Court hearing and judge approval
There are federal and state laws in place to protect people with structured settlements. That’s why judge approval through a court hearing is needed to make sure the transaction is in your best interest and that the terms are not predatory.
The judge looks at factors such as your living expenses, life expectancy, and future financial needs. They’ll also ask the reason for wanting to sell. It’s important to have a true financial need for that money in order to get judge approval. If you simply want to book a once-in-a-lifetime vacation, your sale won’t get approved. Valid reasons could include paying off debt or other bills, covering your mortgage, or buying a house or car.
Tax Implications of Cashing Out Settlements
Cashing out your settlement is tax-free. That’s because the IRS does not consider payments from structured settlements as income. As a result, they’re not taxed as income.