When a plaintiff in a personal injury case settles the case for a large amount of money, sometimes it makes sense for the money to be paid out over time in the form of an annuity rather than being paid in a lump sum. A structured settlement is an arrangement through which the plaintiff agrees to receive the settlement through periodic payments made on an agreed schedule instead of as a lump sum.
A structured settlement will normally require payment of an initial sum of money to the plaintiff, with additional payments to be made over a period of years.
When a plaintiff agrees to a structured settlement, the defendant's insurance company will normally purchase of one or more annuities to fund the settlement. An annuity is a type of insurance or financial product that guarantees the beneficiary payments on a fixed schedule.
The company that issues the annuity thus guarantees payments under the agreed schedule set forth in the settlement of the injury claim. The parties to the injury claim have great flexibility in defining the schedule. For example, the parties could agree to annual payments for a fixed number of years, they could agree to lump sum payments to be made every few years, or they could agree to have payments made on a monthly basis for the duration of the agreed schedule.
Structured settlements are unusual for cases that involve settlements of $150,000 or less, but become more common for larger settlements. The trade-off between the advantages and potential disadvantages of a structured settlement works against the use of structured settlements for smaller damage awards.
As compared to a lump sum settlement, the potential benefits of a structured settlement include:
Although a personal injury for pain and suffering is tax-free, other elements of a damage award may be subject to taxation. A structured settlement allows any taxable portion of the settlement to be paid out over time, spreading the tax burden over a period of years.
Also, if a settlement is received by the plaintiff and then invested, the return on the investment is taxable. With a structured settlement, the tax-free portion of the settlement can earn interest under the terms of the annuity but that interest remains tax-free when the annuity issues payments to the plaintiff.
Protection of Funds
When a plaintiff has long-term needs, a structured settlement can help ensure that settlement funds are not dissipated before they are needed to pay for those long-term needs. After all, in the wrong hands even a significant amount of money may be quickly spent.
- Some people are not good with money, or have a hard time turning down requests for gifts or loans from friends and relatives.
- An injured person who has long-term needs may benefit from receiving periodic payments that allow for the purchase of modified vehicles or medical equipment.
- In the event of financial abuse, the structured payments limit the amount of money that can be misappropriated from the beneficiary of the settlement.
A minor who receives a structured settlement may benefit from having the funds paid out over a schedule that provides limited payments during childhood, payments that cover college tuition during early adulthood, and one or more later disbursements during adulthood.
As the parties to a settlement agreement have broad discretion to define a payment schedule that serves the plaintiff's needs, the parties can fashion a schedule that takes the plaintiff's situation into careful consideration.
- The settlement will typically include an initial lump sum to pay legal fees and the cost of litigation, and to provide funds directly to the plaintiff.
- The payment schedule can be very flexible, with frequent or infrequent payments. For example, payments can be monthly, annual or biannual, or made every few years.
- Payments may also be structured around expected future family needs. For example, a parent's structured settlement may provide for payments to be received when children reach college age so that the parent may help pay a child's tuition.
- A structured settlement may provide for the availability of payments that will cover possible unexpected events or contingencies.
As the defendant insurance company receives tax benefits from entering into a structured settlement, at times it may be possible for the parties to a lawsuit to reach a mutually acceptable structured settlement even when they cannot agree on a lump sum settlement.
While structured settlements may offer a variety of advantages, they also have some potential downsides:
Annuity Payments vs. Investment
Although an annuity guarantees an annual rate of return, that rate may turn out to be less than the plaintiff could have obtained through ordinary investment of a lump sum settlement. A plaintiff may also be concerned that the interest rate may be insufficient to keep up with inflation.
A structured settlement may benefit a minor by allowing payments to be structured based upon anticipated life events, such as college attendance, buying a first home, and other likely future events. But it could also be the case that investment of a lump sum settlement would provide for a significantly better financial return over the minor's lifetime, even after considering potential tax benefits from a structured settlement.
Unexpected Financial Goals or Needs
The beneficiary of a structured settlement may feel stuck or trapped by the settlement. For example, the beneficiary may want to purchase a home or new vehicle, yet be unable to afford the purchase because the settlement funds are not available, and they cannot borrow against the future payments due under the settlement.
When an injured person receives public assistance then the government may be able to claim the proceeds of a settlement or annuity to cover the cost of that assistance.
If a plaintiff is receiving Medicaid or other public assistance or expects to receive those benefits in the future, the plaintiff or the guardian or conservator entering into a settlement on behalf of a disabled ward should consult with a disabilities financial planner about their situation before choosing any particular settlement option or structure.
Due to state regulation, annuities are normally a very safe investment vehicle. Although subject to caps, states typically provide guarantees that apply to annuities issued by insurance companies that become insolvent. However, any person entering into a structured settlement must be careful to avoid potential exploitation, including the understatement of the value of annuities that are used to fund the settlement.
Spreading the Risk
For larger settlements, it often makes sense for the settlement to be funded by several annuities, purchased from several different insurance companies.
By dividing the settlement between companies, the beneficiary gains some additional protection against the possibility that the company that issued the annuity will become insolvent or bankrupt. In a worst-case scenario where one annuity becomes uncollectable, the plaintiff would continue to receive scheduled funds from the other annuities.
Most states have passed laws to protect recipients of structured settlements, requiring that insurance companies disclose the amount that they must pay to obtain an annuity to the attorney who is negotiating the settlement. Attorneys who negotiate for injured clients must be careful to understand the cost of the settlement, and to avoid any issues of excessive fees, commissions or overstated value that could cause a client to receive less money through a structured settlement than would be obtained with better disclosure and due diligence.
Clients should make sure that they understand the extent to which their own lawyers have an interest in any financial services sold by or recommended by their lawyers.
Self-dealing by plaintiff's counsel is not an issue when the defendant's insurance company purchases the annuity. However, it can be an issue when the lawyer tries to convince a client to use a lump sum settlement or payment to purchase an annuity or similar financial product.
Some lawyers are in the insurance business, and may fail to disclose to clients that they intend to purchase annuities from their own business, or that they will receive considerable commissions for the client's annuity purchase. Some lawyers will refer clients to financial professionals who pay referral fees back to the lawyer.
What Happens if You Pass Away
Some annuities provide for payments to be made to a survivor when the initial beneficiary passes away, but other annuities stop paying benefits when the beneficiary passes away. An experienced financial planner can help the plaintiff understand the options and costs, and choose a settlement plan that best serves the plaintiff's needs.
It may seem like any annuity should contain a provision for survivorship. However, the beneficiary of a structured settlement may benefit from an annuity that makes payments for life based upon the beneficiary's life expectancy at the time the annuity is purchased. For example, if the beneficiary's life expectancy is calculated as fifteen years, but the beneficiary lives for twenty-five years, such an annuity will continue to pay out for the full twenty-five years.
At the same time, some payment schedules are based upon factors other than life expectancy. Also, sometimes the beneficiary will prefer that payments continue to be made to a survivor for the remainder of the agreed payment schedule, even though an annuity with a survivor provision may be more expensive than one that does not provide for survivorship.
The beneficiary of a structured settlement should understand whether the annuities will continue to make payments to survivors, or if any unpaid balance will be kept by the insurance company.
If you are the beneficiary of a structured settlement, you have almost certainly heard advertisements for companies that purchase structured settlements. You may be curious about that option, and whether it makes sense to sell your settlement for a lump-sum amount.
Most states require court approval for sale of a structured settlement. Structured settlement that are structured to be tax-free may also be subject to federal regulation limiting their sale to a third party. Some insurance companies that issue annuities may restrict the sale or assignment of those annuities to third parties. Due to restrictions on the sale of structured settlements, upon investigation you may learn that the sale is not possible in your state or circumstance.
If sale is possible, remember that the companies that purchase structured settlements do so for the purpose of making a profit. Sometimes the amount that they will offer to purchase a structured settlement will be surprisingly low.
Before you consider selling your settlement:
- Consult a qualified attorney or financial professional so that you understand your rights and the legal steps that may be required prior to sale;
- Seek offers from more than one prospective buyer so that you can obtain the highest value for your settlement;
- Be careful to only work with established, reputable buyers so that you can avoid the possibility that the buyer will become insolvent after you transfer your settlement but before you receive payment; and
- Act in your own best interest, and don't give up a significant future benefit that is guaranteed under your structured settlement for an inadequate lump sum payment.
If you are concerned about whether or not to enter into a structured settlement, the best time to raise your concerns is before you enter into the settlement. Even if you end up agreeing to a smaller settlement amount in order to obtain a lump sum settlement, the odds are that the smaller lump sum will be significantly greater than any amount you would later receive upon selling your structured settlement.