What is a Structured Settlement
A structured settlement is an alternate way to receive a damages settlement. Rather than a large payment now, the claimant agrees to receive regular payments at set times in the future. For example, a claim might pay damages of $10,000 a month for the next 15 years. This would be $1.8 Million paid as an income over 15 years instead of getting a one time big large payment now.
Structured settlements are most commonly used to settle liability and personal injury claims. They became popular in the 1970's when the IRS declared that payments from some structured settlements are 100% tax free, if the claim complies with section 130 of the U.S federal tax code.
Once they are set up, the claimant knows precisely how much they will be paid and at what times. There is no chance of the amounts decreasing because of poor investment markets, and in many cases, there is no tax bill to worry about. Structured settlements provide guaranteed tax free payments in the future.
Each structured settlement is slightly different because they are specifically tailored for individuals who have different financial needs in the future. The size and frequency of future payments can be tailored to suit the preferences of any financial plan.
How Does A Structured Settlement Work
The ongoing payments from a structured settlement are arranged using an investment product known as an annuity. This is a financial instrument similar to a term deposit which allows people to invest a lump sum today to earn interest and to receive ongoing regular income payments in the future. Annuities are sold by both life insurance and investment companies. Once an annuity has been established, the terms are contractually binding and can not be altered. It is however possible for an annuity to be sold on the secondary market.
In most states annuities are protected by laws which means that future payments are guaranteed. There is no risk of losing your savings if the company who issued it goes out of business. This means that the future income streams offered through structured settlements are protected by the same laws and offer certainty of future income.
In the case of a structured settlement, the claimant does not own the annuity (if they did, the future payments would not be tax exempt). The insurance company paying out the claim will send money to an 'assignment company'. This assignment company will then purchase and hold the annuities and make future payments to the claimant according to contractual agreement.
Who Uses Structured Settlements
One of the main benefits of structured settlements, is that they offer certainty in the future. They reduce the risk that insurance claimants will mismanage their damages award, and run out of money too quickly. Structured settlements are often used in cases involving children, as they can be customized to cater for the anticipated future needs of the child. A structured settlement will ensure that the cash comes to the child over several years and therefore can not run out before the end of the structured settlement term.
For example a settlement might pay very little for the first few years, then provide a lump sum when the child finishes high school. This lump sum can help them at a time when they might need to pay for college or consider buying their first home. Structured settlements are a useful option for anyone who would rather receive a portion of their insurance claim as an income stream rather than a lump sum payment.
Accepting a Structured settlement arrangement does not mean that plaintiffs can't get any money upfront. It is possible to have part of a claim paid right away with the remainder paid through a structured settlement. This option is not just for large insurance payouts. Even claims (or partial claims) of $50,000 or less can be paid out using a structured settlement.
A potential risk with structured settlements is that once they have been set up, the terms can not be altered and you can not draw on your future payments. It is important that plaintiffs work with a qualified financial professional to help set the terms of their structured settlement so that they have cash available for emergencies as well as for ongoing expenses
Is a Structured Settlement Right For You?
Whether or not a structured settlement is suitable for you, depends entirely upon your own circumstances. You should speak to qualified legal and financial consultants before making your final decision. If the certainty of tax free future income sounds better than a large upfront payment, then you should consider taking a structured settlement.
Before you agree to a structured settlement, you need to understand that you are locking in your damages claim for several years. You will only have access to the payments as they are set out in the contract. If there is an unforeseen emergency and you need extra funds, you will not be able to draw down on your future payments. If a structured settlement is not set up correctly, it could fail to meet the financial needs of the plaintiff
How Much Should Your Structured Settlement Be
If you decide to use structured settlements for all or part of a damages award, you will need to ensure that the amount you are getting is fair. This is not as straight forward as it sounds. Imagine if you are entitled to damages of $1.5 Million, and you decide that you'd prefer to receive this are annual payments over the next 15 years. How much per year should they be paying you? If you divide $1,500,000 by 15 years, that's $100,000 per year would you accept this deal? I wouldn't!
Money today is worth more than the same amount in the future. This is because inflation causes the value of cash deteriorates over time. As prices go up, it takes more cash to purchase goods and services that could have been bought more cheaply in the past. Money today can also be invested to earn interest. Investors call this gradual devaluing of cash 'time value of money'.
Structured settlements often cost insurance companies less than a lump sum settlement would have. This is because plaintiffs agree to terms which do not include the time value of future payments. The annuities used to set up structured settlements are purchased at their 'present value', which is less than the sum of all the future payments. The present value is adjusted to include the expected return on investment (interest) the funds will earn while they are on deposit in the annuity. The size and frequency of the future payments will influence the present value.
If you intend to receive part of a damages claim as a structured settlement then it is important to work with a financial professional who understands time value of money and can help you negotiate fair terms for your future payments.
Can You Sell Your Structured Settlement
Once a structured settlement has been set up, the terms can not be changed. Your future payments are guaranteed, but you can't draw down on them before they are due. If you need extra cash for an emergency, then your only option is to sell your guaranteed future payments to someone else. It is possible to sell either all or part of your structured settlement, but selling a structured settlement is not an easy process
A structured settlement is a legal contract, you will need a lawyer to help you make any changes. Selling a portion of a structured settlement requires a lot of paperwork, and needs to be approved in court by a judge. When you sell a structured settlement, you are cancelling your future income payments. You will need to have a day in court to show that you urgently need the money now, and that you and your family can live without it in the future.
If you need to sell all or part of your structured settlement payments, you will need to find a buyer. The buyers in the secondary market for structured settlements are called factoring companies. There are several factoring companies around, some of them even advertise on t.v. It is important to shop around and speak to several factoring companies to find the one that will offer you the best deal.
The factoring companies are buying your annuities with the goal of making a profit. Therefore it is not in their best interest to offer you the best possible price for them. It is possible that you would be financially better off if you don't sell. This is why it is important to work with a trusted independent financial adviser, who can help you determine if selling is the only option, and can also help you to ensure you are getting a fair price for your structured settlement.