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The following questions and answers are not intended to be inclusive of each and every issue that may arise in deciding whether or not to pursue and/or how to implement a structured settlement. These are basic questions that are relevant to almost every case. If you have other questions, or if you require more expansive answers than those provided here, we urge you to contact us directly. We are always eager and available to answer your questions, regardless of whether or not you decide to pursue a relationship with our firm.
What is a structured settlement?
A structured settlement is an alternative to an all-cash settlement in a personal injury case. One portion of the settlement consists of an upfront lump sum payment to satisfy immediate cash needs such as attorney fees, liens, and cash to the plaintiff. The remaining portion of the settlement is used to fund future periodic payments.
A structured settlement is a secure plan that eliminates the risks associated with financial markets. The goal of a structured settlement is not capital appreciation, but rather to provide absolute income protection so that a claimant never runs out of money.
Why did structured settlements come into being?
Studies showed that 90% of all legal awards exceeding $50,000 were dissipated within five years of being made. Structured settlements are simply good public policy. In 1982, Congress recognized the unique financial needs of injured individuals and passed the Periodic Payment Settlement Act, which formally recognized and encouraged the use of structured settlement annuities (and protected them from taxes). Structured settlements protect injured individuals and ensure they receive the necessary financial help without risk of losing their money.
What are the tax consequences of a structured settlement?
Payments from a structured settlement are received income tax-free (federal, state, and local) pursuant to Internal Revenue Code Section 104(a)(2) and as outlined in Code Section 130. Congress enacted these provisions to encourage and facilitate the use of structured settlements to help protect injured parties.
Who establishes a structured settlement?
The defendant or its insurer must arrange the structured settlement in order for the settlement to comply with the Internal Revenue Code. The claimant cannot establish his own structured settlement or own the annuity contract that funds the periodic payments.
How is a structured settlement commonly funded?
A structured settlement is typically funded by the purchase of an annuity contract from a highly-rated legal reserve life insurance company. The defendant or its insurer pays the specified amount of money to the life insurance company, which in turn promises to pay the agreed-to periodic payments. For further diversification, sometimes the structured settlements are funded through more than one life insurance company.
How does a claimant know what his/her periodic payments will be?
The structured settlement broker surveys the marketplace in search of the most competitive rates for funding annuities. The result of the survey is illustrated and presented during the negotiations.
If agreement is reached, the annuity arrangement is "locked in" with the issuer. The payments can be tailor-made to match the anticipated future needs of the claimant. If a particular benefit package is not desirable, the claimant (or the claimant’s attorney) can request different proposals. Once a benefit package is created that is agreeable to both parties in the suit, the annuity can be funded.
When must a structured settlement be arranged?
A structured settlement must be arranged and agreed to at the time of settlement because the details of the periodic payments must be included in the settlement agreement and court documents. A claimant cannot receive settlement money and then decide to use a structured settlement annuity in order to benefit from its tax and other advantages.
What are the benefits of a structured settlement?
- Tax-Free Income: All income from a structured settlement annuity is completely tax-free to the recipient. The benefit of tax-free income is paramount. Virtually no other financial product can match it.
- Guaranteed Income for Life: If a life annuity is used, income is guaranteed for the life of the claimant. An annuity is unique in that it is the only financial product that will generate guaranteed income for the lifetime of an individual.
- Avoidance of Financial Risk: Income from a structured settlement annuity is guaranteed. The claimant shifts the investment burden to the life insurance company that issued the annuity contract. The life insurance company’s contract guarantees all income with its full faith and substance.
- No Management or Investment Fees: Alternative investment plans often have significant fees, including: advisor fees, investment management fees, legal fees, and accounting fees. Fees can reduce returns on alternative investment plans by 2% to 5% per year.
- This aspect alone places an annuity in a totally different category from any other financial plan.
- Financial security of highly rated life insurance companies: Payments are guaranteed by life insurance companies rated at least A+ by A.M. Best, Aa3 by Moody’s and AA- by Standard & Poor’s and Fitch.
How can I tell if a structured settlement is right for a particular claimant?
First, keep in mind that the entire settlement amount does not have to be used to provide for future periodic payments. It is almost always important to receive some of the settlement proceeds in immediate cash. But structuring a portion of a settlement will be in a claimant’s best interest if any of the following apply:
- Claimant is incompetent or a minor
- In fact, laws in many states limit the investments that can be made on behalf of such a plaintiff. Annuities are almost always preferable to the other available investments.
- Claimant is uncomfortable or inexperienced managing and investing large sums of money
- With an annuity, the life insurance company assumes both the responsibility and the risk of investing the claimant’s money.
- Claimant has a conservative nature (i.e., claimant is not interested in investing in the stock market)
- A structured settlement annuity is not a capital appreciation investment. Rather it is meant to provide absolute income security that protects the claimant from ever running out of money.
- Claimant desires consistent and guaranteed income (e.g., income replacement or lifetime medical care)
- Claimant needs lifetime income
- Claimant cannot risk depleting his or her money (e.g., claimant needs lifetime medical care and settlement proceeds are the only monies available to pay for care)
- Claimant lacks self-discipline (i.e., spending cash settlement too quickly and/or wastefully)
- Claimant is a minor and there is a concern with providing too much money too soon to the claimant.
- Payments can be deferred until a claimant is older and likely to be more responsible.
Structured settlements are not a panacea. They are not suitable for every case involving personal injury or wrongful death. However, they are a very valuable tool in many cases, and can provide benefits that no other investment option can match.
I have contacted a financial consultant and he has not recommended a structured settlement. Why not?
The vast majority of financial planners and consultants are not approved by life insurance companies to sell structured settlement annuity products (i.e., tax-free annuities designed especially for claimants in personal physical injury cases). In addition, annuities do not generate any continuing advisory or management fees for financial consultants the way many other investments do.
What rate of return can be expected from a structured settlement annuity?
The internal rate of return provided by a structured settlement annuity will depend upon market interest rates at the time of purchase. However, it will always be competitive compared to the rate of return of other fixed income investments.
In fact, because a structured settlement provides tax-free income, the equivalent
taxable yield (i.e., the yield that a taxable investment must achieve in order
to produce the same after-tax rate of return) is almost always very superior, very often considerably so - especially considering there is no investment risk to the claimant. In order for an alternate investment to produce the same after-tax returns, the claimant almost certainly would have to accept significant investment risks.
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