A structured settlement is a type of annuity that pays out an award from a civil lawsuit by spreading the payments out over a long period of time. A structured settlement many times offers a better future guarantee of money than a lump-sum payout.
What Is a Structured Settlement?
Structured settlements are simple. Many lawsuits result in someone or some company paying money to another to right a wrong. Those responsible for the wrong may agree to the settlement on their own, or they may be forced to pay the money when they lose the case in court.
A structured settlement is a stream of payments to a person who won or settled a lawsuit. The defendant funds the settlement. These resolutions differ from lump-sum settlements because of the way the money is paid over time.
If the amount of money is small enough, the wronged party may have the option to receive a lump sum settlement. For larger sums, however, a structured settlement annuity may be arranged.
In this case, the at-fault party puts the money toward an annuity, which is a financial product that guarantees regular payments over time from an insurance company.
The agreement details the series of payments the person who was wronged will receive as compensation for the harm done to them. Spreading the money over a longer period of time offers a better future guarantee of financial security because a single payout can be spent quickly.
Structured settlements gained popularity in the 1980s after the U.S. Congress passed the Periodic Payment Settlement Act. According to the National Structured Settlements Trade Association, almost $6 billion in new structured settlements are issued annually.
Frequently Asked Questions: Get straightforward answers to common questions about a structured settlement annuity.
How Do Structured Settlements Work?
A structured settlement pays out money owed from a legal settlement through periodic payments in the form of a financial product known as an annuity. However, many legal settlements offer a lump-sum payment option, which provides a one-time sum of money. The key differences between both annuity settlement options are the long-term security and the taxes. For example, money received from a personal injury case is almost always tax free when you receive it. However, once the money is yours, you’re liable for taxes and dividends from the lump sum.
There are a number of reasons why an individual may receive a structured settlement. The most common cases are:
Personal Injury: A personal injury case is a civil case where someone who’s been harmed files a lawsuit seeking money from the person believed responsible for the harm. Money in the form of a structured settlement helps recipient pay for medical expenses or other costs.
Workers’ Compensation: Most people know about workers’ compensation, which pays workers who get injured on the job while they recover. Payments can be used for medical treatment and wage replacement during periods when injured employees are unable to work and other expenses.
Medical Malpractice: In some unfortunate cases, doctors can do more harm than good. In this instance, injured patients or the families of deceased patients can sue for medical malpractice.
Wrongful Death: A structured settlement is also a common way to compensate family members who claim loved ones were victims of wrongful deaths. Families may be entitled to receive a stream of tax-free payments, to replace income after a loved one’s death.
Structured settlements — or structured annuities — are both financial products and legal judgments. While they function somewhat like private assets, they are also subject to complex regulations. Learn about the process of being awarded a structured settlement annuity as well as the legal protections and advantages on the following pages:
Structured Settlement Payout Options: Compare and contrast the different ways to accept a cash settlement from a lawsuit.
Government Support for Structured Settlements: Learn about how the government uses the tax code to promote their use.
Structured Settlements for Minors: Read about why this type of settlement is typically used in cases involving children.
Payout Options for Structured Settlements
If you elect to receive your lawsuit payout through a structured settlement, you can determine whether to begin to receive the funds immediately or at a later date. Immediate payments can be beneficial if you require medical care, for example, or have lost your source of income. You may decide to postpone the payments until a later time, such as after you retire. During the waiting period, the annuity will grow as it earns interest.
You can also determine whether the annuity should be paid for the rest of your life, no matter how long that may be, or for a specified number of years.
You can also determine when you set up the annuity the schedule for receiving payments and whether the payments should go up or down over time.
Structured Settlement Pros and Cons
Structured annuities are ideally suited for many different types of cases. For additional information on how work, payout options, or how to access your cash ahead of the annuity contract schedule, the Structured Settlements FAQs page can be a beneficial resource.
These scheduled payments offer a number of advantages. When deciding on any financial investment, it is important to understand the benefits along with the risks.
Pros of Structured Settlements
Payments are tax-free.
In the event of the recipient’s death, the heir can continue to receive tax-free payments.
Payments can be scheduled for almost any length of time and can begin immediately or be deferred for as many years as requested. They can include future lump-sum payouts or benefit increases.
Spreading out payments over time can reduce the temptation to make large, extravagant purchases and guarantees future income. This is especially helpful if the recipient has a medical condition that will require long-term care.
Unlike stocks, bonds and mutual funds, structured settlements do not fluctuate with market changes. Payments are guaranteed by the insurance company that issued the annuity.
A structured settlement often yields, in total, more than a lump-sum payout would because of the interest your annuity may earn over time.
Cons of Structured Settlements
Once terms are finalized, there’s little you can do to alter them if they do not meet your needs. You cannot renegotiate the terms if your financial situation or the overall economy changes.
Funds are not immediately accessible in case of an emergency, and the recipient cannot place a lump-sum payout in other investments that carry higher rates of return.
Tapping into your structured settlement without selling payments will cost you money. You will pay surrender charges and IRS penalties if you withdraw funds before age 59½.
Some parts of a settlement, such as attorney’s fees and punitive damages, can be taxed.
Not all states require insurance companies to disclose their costs to establish a structured settlement or lump-sum annuity. Without this information, a recipient could lose a significant amount of money through administrative fees.
Options for Annuity Owners to Sell Payments
You should carefully consider the terms of your annuity because they can’t be renegotiated after the contract has been issued. That can limit your options if your financial situation changes due unemployment, illnesses or other setbacks.
However, annuity owners may have the option to get cash in advance of their contract schedules. Owners may sell some or all payments to structured settlement buyers. Such sales must be approved by a judge. The role of the judge is to decide if the sale is in the best interest of the annuity owner.
Other rules may apply depending on the details of your annuity contract and the laws of the state where you live. The Structured Settlement Protection Act of 2002 provides federal guidelines on such transactions.
Annuity owners should carefully consider their options before selling payments. You can learn more at Selling Structured Settlement Payments.
How Do Structured Settlements Work?
Explore the topics in this section to gain a full understanding of the different forms structured settlements can take and the reasoning behind them.
Being Awarded a Structured Settlement
The process of settling a civil case through a structured settlement involves the person who has been wronged (the plaintiff), the person or company who caused the harm (the defendant), a consultant experienced in such cases (a qualified assignee) and a life insurance company.
The plaintiff sues the defendant to seek compensation for an injury, illness or death the defendant caused. Often the defendant agrees to give money to the plaintiff through a structured settlement in order to keep the lawsuit from going to trial. If the case does go to trial and the judge rules in the plaintiff’s favor, the defendant may then be forced to set up a settlement.
The defendant and the plaintiff work with a qualified assignee to determine the terms of the structured settlement agreement — that is, how much the regular payments should be, how long they should continue for, whether they should increase or be supplemented by larger payouts at certain times, and so on. The defendant provides money for the qualified assignee to buy an annuity for the plaintiff.
The qualified assignee purchases an annuity from a life insurance company, setting up the annuity contract to match the settlement needs. Once the terms of the annuity are set, they cannot be changed. An immediate lump sum may also be set aside to cover attorney fees or to fund a specified trust.
The life insurance company pays the plaintiff a series of payments over time, according to the terms of the annuity contract. The annuity earns interest to protect its value from inflation, and the only way for the plaintiff to get cash from the settlement ahead of schedule is to sell the right to future payments on the secondary market.
Calculating the structured settlement amount can be a complex financial task. A financial advisor or lawyer will typically hire an economist to help calculate the value of the contract.
Structured Settlements Pros and Cons
Structured settlement payments do not count as income for tax purposes, even when the structured settlement earns interest over time.
Income from structured settlement payments also does not affect your eligibility for Medicaid, Social Security Disability benefits or other forms of aid.
In the event of the recipient’s premature death, the contract’s designated heir can continue to receive any future guaranteed payments, tax-free.
Payments can be scheduled for almost any length of time and can begin immediately or be deferred for as many years as requested. They can include scheduled lump-sum payouts or benefit increases in anticipation of future expenses.
Spreading out payments over time can reduce the temptation to make large, extravagant purchases, and it guarantees future income. This is especially helpful if you have a medical condition that will require long-term care.
Unlike stocks, bonds and mutual funds, fluctuations in financial markets do not affect structured settlements.
The insurance company that issued the annuity guarantees payments. Even in the unlikely event that the insurance company becomes insolvent, your state’s insurance guaranty association still protects you from loss.
A structured settlement annuity contract often yields, in total, more than a lump-sum payout would because of the interest the annuity may earn over time.
Once the terms of a settlement are finalized, there’s little you can do to alter them if they do not meet your needs. You cannot renegotiate the terms if your financial situation or the overall economy changes.
Funds are not immediately accessible in case of an emergency, and you don’t have the opportunity to use the full amount of the settlement for investments that carry higher rates of return.
Tapping into your structured settlement benefits without selling payments will cost you money. You will pay surrender charges and IRS penalties if you withdraw funds before age 59½.
Some parts of a settlement, such as attorney’s fees and punitive damages, can be taxed.
Not all states require insurance companies to disclose their fees for establishing a structured settlement or lump-sum annuity. Without this information, you could lose a significant amount of money from your settlement through administrative fees.
Understanding Structured Settlement Annuity Contracts
Structured settlement agreements are designed to provide periodic payments over a fixed number of years. However, the plaintiff can decide how the money is distributed and how much is provided yearly. Structured settlement benefits can be delayed until retirement, or awarded through a large lump sum payment, with complementary smaller payments over time in order to pay bills or relieve debt. Benefits can also act as an additional yearly income stream, with payments increasing or decreasing through the agreement term. These types of settlements have become more common over the years because of the advantages they offer to individuals and their families.
Lawsuit Payout Options: Lump sum settlements come with the most freedom and the most risk. Structured settlements, on the other hand, are flexible to set up but rigid once awarded.
Lump Sum Settlement Considerations
The Flexibility of Structured Settlements
Start and End Dates
Payment Frequency and Amount
Government Support for Structured Settlements: Thanks to the Periodic Payment Settlement Act of 1982, many annuities awarded through lawsuits are exempt from income taxes.
Ensuring Money for the Long Term
The Pitfalls of Lump-Sum Settlements
Qualified Versus Unqualified Settlements
The Tax-Free Status of Qualified Structured Settlements
Structured Settlements for Minors: Structured settlements are considered ideal for ensuring that an underage child’s cash settlement is preserved and spent appropriately.
Ensuring Money for a Child’s Future
How Minors Benefit from Structured Settlement Agreements
Designing a Minor’s Structured Settlement
Structured Settlements Versus 529 Plans