How Does a Structured Settlement Work?
A plaintiff receives a structured settlement after successfully winning a lawsuit against a defendant. In many cases, the defendant purchases an annuity from an insurance company , which is then responsible for the series of scheduled payments. So instead of getting a lump sum, you’ll receive a fixed payment over a set amount of time.
Structured Settlement Payout Options
A structured settlement is typically offered when a person is awarded a large amount of money. While smaller award settlements are typically paid out in one payment, larger awarded sums may be offered as a structured settlement annuity, so the awarded amount is paid out over a specific time period.
Benefits of Structured Settlements
- A structured settlement can provide a greater level of financial stability for long-term injuries or disability.
- The structured settlement payments are tax-free.
- Structured settlement annuity accounts gain interest which can give the injured party more money in the long run.
- The settlement helps to replace any lost income experienced by the plaintiff.
- The payments can be set up to be passed on to a survivor after the death of the beneficiary.
- The payment does not fluctuate with market conditions.
- Lowered risk of making bad financial choices when compared to receiving a large lump sum.
Disadvantages of a Structured Settlement
- No flexibility, edits, or changes once the settlement terms are established.
- Hard to use monthly payments as an emergency fund, compared to a lump sum payment
- Low interest earned compared to other savings or investment vehicles.
- You can negotiate a settlement buyout, but will pay a discount rate to a purchasing company.
Issuers of Structured Settlement Annuities
- New York Life
- Berkshire Hathaway
- Prudential Financial
- Liberty Mutual
- Mutual of Omaha
- Pacific Life
- USB Financial
How are Structured Settlements Taxed?
If you receive a structured settlement, you may wonder about the impact of those payments on your taxes and how those payments need to be reported to the IRS.
Due to the Periodic Payment Settlement Act that was signed into law in 1982, nearly all structured settlements resulting from personal injury lawsuits are tax-free. The reason structured settlements are not taxed is that the federal government does not view structured payments as income, but rather restorative payments to right a wrong that has been done to you.
What Happens If A Beneficiary Takes Over?
If the individual receiving the structured settlement payments passes away, the payments may be transferred to a beneficiary. However, before passing away, the owner of the structured settlement must be sure to include a death benefit that allows for the transfer of funds.
Taxes for the beneficiary’s takeover of the annuity are treated in the same way as they would be for the original owner. The transfer will not trigger taxation unless the stipulations of the structured settlement contract have been changed.
Cases That Result in a Structured Settlement
There are multiple types of court cases that could result in a structured settlement for the plaintiff. Here are four of the most common scenarios.
1. Personal Injury
A personal injury lawsuit is a civil case in which a plaintiff has been harmed and is seeking money from the defendant, whom they believe to be responsible for the sustained injury. Oftentimes, plaintiffs in personal injury lawsuits are awarded a structured settlement to cover medical expenses or other ongoing costs.
2. Medical Malpractice
A medical malpractice structured settlement is a form of compensation given to an individual who has been harmed due to a doctor’s negligence. The structured settlement is designed to pay the injured party for a certain period of time.
The settlement provides the individual with a reliable source of income that can help pay related medical bills and help with other financial needs.
3. Wrongful Death
A wrongful death claim may be filed when the victim’s death was caused by the direct actions or negligence of another party. As with any civil lawsuit, a wrongful death case often ends with a settlement agreement or a compensation award. When a large sum of money is awarded, the amount is usually paid out as a structured settlement.
When a wrongful death occurs, the surviving family members, such as the spouse and children, often find it difficult to make ends meet after the loss of income occurs. Choosing a structured settlement means payments continue for years and can be used to maintain the standard of living the family was accustomed to before the death of their loved one. The awarded settlement payments can even be passed on to an heir, should the plaintiff become deceased before their final payment is paid out.
4. Worker’s Comp
Worker’s compensation laws were put in place to protect injured workers. These laws require employers to carry insurance to cover claims in case a worker becomes injured on the job. When an injured employee is awarded a worker’s compensation settlement, they may receive a lump sum payment or may be offered a structured settlement.
A worker’s compensation structured settlement is meant to partially replace the wages the worker would earn during their recovery period. It can also be used to replace the wages the worker would have earned throughout their lifetime in the event they became permanently disabled on the job.
What Should Be Known About Structured Settlements for Minors?
While the vast majority of minor and adult structured settlements are set up in the same manner, there is one primary difference. Until they turn 18, minors have little to no say in how their structured settlement is set up or spent. Instead, the minor’s parents or guardian remain in control of the structured settlement and must spend the money according to the specifications ordered by the judge. Once they reach 18 years old, the minor can take over control of their structured settlement.
The Judge Stipulates How the Money Will Be Spent
A judge will oversee how the structured settlement is spent and holds the parents or guardian to specific guidelines that prevent them from spending the money irresponsibly or for purchases that do not benefit the child.
The main goal of a structured settlement is to ensure the minor has money for their future. If a lump sum were paid out while the individual was a minor, the funds could potentially be spent before the child turns 18, so creating a structured settlement incorporates an extra level of financial protection.
Selling A Structured Settlement
While a structured settlement may work well at the beginning, it does not account for any future changes to your financial situation. For instance, a monthly stream of payments over several years couldn’t help to pay off debt, buy a house or car, or cover a major medical event.
It is, however, to swap out some or all of those monthly payments for a lump sum by selling your structured settlement. Alternatively, you could just sell a portion of your payments to cover a short-term need, then continue to receive payments in the future.
Shop around to get offers from multiple structured settlement buyers in order to get the best deal. You’ll find purchasing companies charge a discount rate, which can vary among offers. Usually totaling between 9% and 20% of your structured settlement value, the discount rate is calculated based on things like how many payments you’re selling, current market rates, and how long the payments last. If you have a 10% discount rate on a settlement valued at $50,000, then you would just receive $45,000.
Structured Settlement Laws
Periodic Payment Settlement Act
Over the years, laws have been put into place to protect the rights and best interests of structured settlement recipients. The Periodic Payment Settlement Act was enacted in 1982 as a means of protecting individuals and encouraging them to accept structured settlements for their financial security.
While this law provides a few different benefits, one of the biggest is that it allows individuals to receive their structured payments tax-free. The structured payments do not have to be included in the gross income report for income tax preparation.
It is important for structured settlement recipients to understand a stipulation that could prevent the tax-free status from applying to an individual. The act states individuals cannot defer, accelerate, or decrease their structured payments or the tax-free status becomes null and void.
Additional Laws Were Put Into Place
In the 1990s, advertisements began popping up that offered structured settlement recipients the option of receiving a lump sum instead of monthly payments. When unscrupulous factoring companies began taking advantage of individuals, a new act was signed into law to stop this illegal activity.
Structured Settlement Protection Act
Protection at the State Level
Each state has its own laws that have been put into place to protect structured settlement payment holders from being taken advantage of. Although each state has different laws in place, there are some similarities across the country.
- When a company agrees to purchase a structured settlement, they are required to provide information on the difference in value between the sale price and the value of the payments if the agreement is left intact.
- A judge must approve the transfer of payments in order to make sure the transaction is in the best interest of the individual.
- A disclosure statement must be provided that clearly summarizes the terms of the transaction the individual has agreed to.
- A cooling-off period is granted to the individual to give them time to cancel if they change their mind.
- The entire transaction must abide by all applicable state and federal laws.
Some states require individuals to seek out an independent professional advisor to ensure they fully understand the implications of selling their structured annuity. Other states may only recommend this counseling rather than require it.
The Federal Structured Settlement Protection Act
The Federal Structured Settlement Protection Act was signed into law in 2002. It helps to ensure the main components of state laws and regulations are standardized.
This Act was put into place to further cement the protection of the individual and to ensure the structured settlement sales process is fair. Here are two of the most important components addressed in state law:
- All transactions must be court-approved and in compliance with all state laws and regulations.
- If a structured settlement transfer does not comply with the laws, a 40% excise tax will be required.
All of these laws share the common goal of protecting people from unscrupulous buyers who simply want to profit at the expense of desperate individuals.
Individuals need to carefully study the laws and regulations and research their own state’s Structured Settlement Protection Act to ensure the transaction is compliant. These laws can help to protect you and ensure the transaction is a fair one that will benefit your financial needs.
Federal and State Laws Protect Structured Settlement Recipients
While these laws may seem intrusive to the recipient, they were put in place to offer protection. A structured settlement is meant to provide financial security for an individual’s future and having certain requirements and regulations put into place help ensure the awarded money is not squandered or misused.
Those who have received a structured settlement award need to be aware of these two federal laws and how they offer protection and guidelines. With knowledge of these laws, structured settlement recipients can remain proactive in protecting their money throughout the various stages of receiving and selling a structured settlement.