What is a structured settlement?
Perhaps you have been the victim of a wrongful personal injury. You (defendant) file a claim against the individual or company that has wronged you (plaintiff), and you settle the case out of, or in court. The court awards you a settlement for, hypothetically, one million dollars. You get excited just thinking about your one million dollar check! But not so fast…
Sometimes when a plaintiff settles a case for a large sum of money, the defendant, the plaintiff’s attorney, or a financial planner consulted in association with the settlement, will propose paying the settlement in installments over time rather than in a single lump sum. When a settlement is paid in this manner it is called a “structured settlement”. Often the structured settlement will be created through the purchase of one or more annuities, which guarantee the future payments.
What types of structured settlements are available?
Installment payments can be structured in a number of ways to suit your needs and to protect you from inflation. They can range from a simple yearly payment to complex arrangements consisting of an initial lump sum payment, monthly indexed installments, deferred payments, and special provisions relating to the future care or death of the insured. There are several types of payment plans listed below, however, it is important to note that an experienced lawyer or financial planner should guide you to a settlement plan that will work best for you.
Life with Period Certain or Life Annuity
One type of annuity is commonly referred to as either Life with Period Certain or simply as a Life Annuity. These settlements are paid in periodic payments for a guaranteed number of years or for life, whichever is up first. The number of years is based on your life expectancy. This works the same way with regard to your beneficiary who will be paid for the remaining guaranteed number of years should you pass away prior to the designated number of years.
Temporary Life Annuity
A Temporary Life annuity pays you periodically for a designated number of years if you are still living. There is no provision for a beneficiary to receive funds after you are gone. In other words, your annuity ends when you die should you pass away before the selected number of years.
Lump Sum/Life Contingent Lump Sum Annuity
It is possible to set up an annuity with a lump sum payment for a future date. You can set it up to receive the sum, for example, ten years into the future. Should you not survive, your beneficiary would receive the lump sum on that future date. Alternatively, the annuity can pay a lump sum with the provision that you are alive on the due date. Then there is no payment to any beneficiary. This is called a Life Contingent Lump Sum.
Life Only/Joint Survivor Annuity
There are also Life Only annuities that pay monthly payments for life with no beneficiary provision. A Joint & Survivor annuity will pay you monthly payments for life, and, if your beneficiary survives you, he or she will be paid monthly payments for the balance of his or her life when you are gone.
Most of these annuities can be designed to suit your needs in terms of how often the payments are made, whether or not you get an up-front lump sum before the periodic payments begin, whether or not your attorney is paid in periodic payments or in a lump sum, etc. It is important that you fully understand all of the information and the terms of the structured settlement prior to agreeing to accept a particular structure, as the terms are final.
What are the downsides to accepting a structured settlement?
As mentioned above, once you agree to the terms of the structured settlement, you are bound by that agreement. You cannot change it at a later date. Hence, it’s very important to be represented by an experienced attorney and tax advisor who will help negotiate structured settlement terms that meet your needs, such as protection from rising inflation.
Some people who enter into structured settlements end up feeling trapped by the periodic payments. They may wish to purchase a new home, or other expensive item, yet are unable to gather the financial resources, because they can’t borrow against future payments under their settlement.
For these reasons, and others, some people will do better by accepting a lump sum settlement, and investing it themselves. Many standard investments can give a greater long-term return than the annuities used in structured settlements.