Awarding a structured settlement annuity – Process, legal protections and advantages

Learn About The Process Of Being Awarded A Structured Settlement Annuity As Well As The Legal Protections And Advantages:

  • Structured Settlement Payout Options

  • Government Support for Structured Settlements

  • Structured Settlements for Minors

 

  • Structured Settlement Payout Options :

Money awarded through a lawsuit can be paid out as a single lump sum or as periodic payments through a structured settlement. Structured settlement annuities can be tailored to meet individual needs, but once agreed upon, the terms cannot be changed.

Some civil lawsuit cases never make it to trial in exchange for receiving lump sum payments. A lawsuit payout or structured settlement is an agreement providing a plaintiff with a fixed monthly income over a period of time. Prior to receiving structured settlement payments, individuals should consider all tax liabilities and discuss all payout options with an attorney or financial advisor.

Lump Sum Settlement Considerations :

Despite the many options available, many lawsuit payouts from civil cases are still paid out as lump sums. There are two key differences between lump sum payments and structured settlements: long-term security and tax liability.

Key differences between lump sum payments and structured settlements

  1. By structuring the money over a longer period of time, a structured settlement offers a better future guarantee of money than a single payout, which can be spent quickly.
  2. Though any kind of settlement for a personal injury case will be tax-free when you receive it, once a lump sum settlement is yours, you’re liable for taxes on whatever you earn by investing it. But interest earned on structured settlements is not taxed, unless they are sold.

Choosing how to receive a cash settlement will have long-lasting personal and tax consequences, and this decision should be made under the advisement of a professional such as an accountant or attorney.

Before accepting a lawsuit payout, you should consider these factors:

Tax obligationsYou must be prepared for the extra tax liability that comes with managing a large single payout. However, personal injury lawsuit settlements are tax-free.
Your financial management skillsYou have to either learn how to manage a large investment portfolio or identify a trustworthy, qualified professional who can do it for you.
How risky your spending habits areBe honest with yourself about how much temptation you’ll feel to spend a large cash payout on expensive things you do not need.

The Flexibility of Structured Settlements

Structured settlements come in many more shapes and sizes than the typical annuities people purchase for retirement income. As part of the settlement negotiation process, a qualified structured settlement broker can design an annuity contract to meet the present and future needs of the recipient and their family.

Start and End Dates

If the settlement recipient requires ongoing medical care and is unable to earn any income, it will make the most sense for the payments to begin immediately.

In other cases, however, the recipient and the broker may agree that it is better for the payments to start at a later time. For example, a recipient may want to defer their payments until they retire, so that the annuity can earn interest faster and continue to grow.

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How long the payments continue depends on whether the annuity is “life only” or “term certain.”

A life only annuity lasts as long as the recipient lives, whether they live 5 years or 50 years after being awarded the structured settlement. The payments are said to be “life contingent” in this case. An annuity can be designed to provide lifelong income for a recipient’s spouse as well, in case the recipient passes away before their spouse does.

A term certain annuity is set to last a certain number of years, no matter how long the recipient lives. This type of annuity provides guaranteed payments. This may pose a risk, however, because if the recipient outlives the annuity, they will have to adjust to living without that source of income. On the other hand, if the recipient passes away before the annuity ends, the beneficiaries specified in the annuity contract will continue to receive the payments for the rest of the annuity’s term.

Payment Frequency and Amount

Terms to know:

Payment Schedule A structured settlement recipient can receive payments at any reasonable regular interval, such as monthly, quarterly, annually or even some combination of schedules.
Increasing Payments One of the greatest strengths of a structured settlement annuity is its ability to earn interest, which can allow the payments to be adjusted upward over time to keep up with inflation. In addition, annuity payments can be set to rise even faster according to a certain schedule. This may be necessary if the costs of the recipient’s health care are expected to increase over time.
Decreasing Payments If health-care costs are instead expected to decrease over time as the recipient recovers, the structured settlement payments can be designed to start high and then decrease. There are certain other cases in which decreasing payments can make sense — for example, if the child of an accident victim is awarded a structured settlement through a wrongful death lawsuit, the payments may be set to decrease as the child comes of age and achieves independence.
Initial Lump Sum In many structured settlement annuities, the periodic payments are supplemented by a larger lump sum payment that comes immediately after the settlement is agreed. This is often necessary to cover attorney’s fees and whatever medical bills have accumulated while the settlement was being negotiated.
Final Lump Sum An annuity can also be designed to have a large lump sum payment at the end. A child recipient may receive regular payments while they are a minor and then one large lump sum to pay for their college tuition as soon as they finish high school.
Periodic Lump Sums A structured settlement annuity may even be designed to have special extra payments that occur less frequently than the normal payments. For example, a recipient may receive a payment every month, plus a larger payment every five years to pay for the cost of replacing and upgrading medical devices.
  • Government Support For Structure Settlement (Periodic Payment Settlement Act)

The Periodic Payment Settlement Act (PPSA) seeks to prevent plaintiffs from spending large cash settlements quickly and unwisely, rather than using the money for long-term security.

Ensuring Money for the Long Term:

The federal government passed the Periodic Payment Settlement Act of 1982 (Public Law 97-473) to protect claimants awarded with cash sums from personal injury and wrongful death lawsuits from quickly depleting their assets and then falling on public assistance to meet their needs.

This is a serious risk, no matter how large the settlement. For example, insurance industry statistics from The Rutter Group show 25 – 30 percent of accident victims use all the funds from their judgments within two months of recovery, and most cash settlements last less than a few years.

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90% of accident victims exhaust their settlement within 5 years.

To protect claimants from such losses, the PPSA created a powerful tax incentive for the use of structured settlements, a type of annuity that converts a one-time award from a lawsuit into a series of income payments that can last up to a claimant’s entire lifetime. In trial judgment terms, these kinds of settlements are known as periodic payment judgments. Spreading out payments in this way provides long-term, tax-free financial security to victims and their families.

According to the National Structured Settlement Trade Association, more than 500,000 injury victims have settled their accident or wrongful death cases with structured settlements since the PPSA was signed into law.

The Pitfalls of Lump-Sum Settlements

Many recipients are unprepared for the responsibility that comes with receiving a large lump-sum settlement. Managing an investment portfolio can be time-consuming and stressful, especially when you are recovering from a personal injury, illness or loss at the same time. Gains from private investments may also create tax liabilities you do not expect, and bad investments could result in losses that jeopardize your ability to pay for future medical bills and living expenses.

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Sometimes a settlement can burn a hole in your pocket.

You may face devaluation of your assets due to market changes, and even if you leave your settlement money in a seemingly riskless savings account, its value will still diminish due to inflation. On top of all that, whenever you receive a large cash payout, it is not uncommon for people to come asking you for a loan.

Structured settlements provide long-term financial security. A structured settlement broker can work with you to set up an annuity contract according to your needs, making sure the terms of the structured settlement anticipate the costs of medical, living and family-related expenses over time.

Qualified Versus Unqualified Settlements:

Structured settlements are often divided into two categories: qualified for tax exemption and unqualified for tax exemption. Exceptions can exist, however, so consult a financial professional when preparing your state and federal taxes.

Qualified:

The traditional structured settlement for physical injury or sickness claims must meet certain requirements in order to qualify for tax exemption. The settlement amount has to be placed in an annuity, periodic payments must be fixed and determinable as to amount and time of payment, the claimant cannot modify the periodic payments, and those payments must be payable to the recipient.

Unqualified:

This type of settlement is used when claims for damages fall outside the usual scope of physical injury, sickness or wrongful death. They are often used for claims involving racial discrimination, sexual harassment, wrongful termination or violation of the Americans with Disabilities Act of 1990 or the Employee Retirement Income and Securities Act of 1974. The tax implications differ among these types of transactions.

The Tax-Free Status of Qualified Structured Settlements

While the PPSA does not mandate the use of structured settlements in any given circumstances, it grants structured settlements a distinct economic advantage over lump-sum payments for the recipients of damage awards. The PPSA amended the tax code to specify the full amount of money given in a structured settlement are damages and, thus, tax-free.

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IRC Section 104(a)(2) states periodic payments after sickness or personal injury constitute damages that are tax-free to the injured party.

Though lump sum settlements for sickness or personal injury are tax-free as well, the key difference is that a structured settlement can earn interest tax-free. If you invest a lump sum settlement yourself, whatever profit you earn on it is taxable.

However, the PPSA also specifies that for a structured settlement to maintain its tax-free status, payments to an injured person cannot be “accelerated, deferred, increased or decreased by the recipient.” Any changes to the agreed settlement would nullify the contract’s tax advantages. The only way to receive funds ahead of schedule without changing the settlement’s tax-free status is to sell a portion of your payments, in accordance with federal and state laws.

  • Structured Settlements for Minors

Children often receive a financial windfall after winning or settling a lawsuit that involves them or their parents. Money gets to minors through a structured settlement that preserves as much of the cash as possible until they turn 18.

Ensuring Money for a Child’s Future

When courts decide or plaintiffs and defendants settle large cases that involve children, the financial result takes into account the child’s long-term stability. Lawyers and courts take steps to protect minors’ financial future by structuring the financial windfall into periodic payments.

These insurance settlements for minors are the result of legal cases that stem from a product-liability claim, a workplace accident in which a parent perished or was severely injured, car accident, or some other serious injury to the child. Periodic payments are beneficial for minors because they reserve money for essential long-term necessities (food, clothing and shelter), future academic expenses, and any continuing medical care.

Structured settlements for minors take the form of an annuity from a life insurance company, just as for adults.

The key difference between an adult owning a structured settlement and a minor owning one is control. By law, minors have little to no say in how their periodic payments are set up, and their parents or guardians must spend the money in the exact manner the court orders.

This setup prevents the minor and their parents or guardians from having unrestricted use of the settlement funds and potentially spending the money irresponsibly or for purchases unrelated to the court-prescribed purposes. The goal of a structured settlement for a minor is to provide for the child’s needs and make sure there is money for the child leftover when he or she turns 18.

How Minors Benefit from Structured Settlements

Today, structured settlement annuities make up the overwhelming majority of lawsuit awards when the financial security of minors are at stake, due to the many advantages of accepting an award in this way.

Advantages of accepting settlements are:

  • The settlement income comes tax-free, even when the annuity earns interest.
  • The settlement does not require maintenance fees.
  • The overall rate of return is fixed, ensuring payments don’t decrease when the stock market dips. The yield typically ranges between 3 – 10 percent.
  • Insurance commissioners regulate structured settlements in all 50 states, and the underlying annuity is protected from creditors and judgments.
  • Until the child is 18, the money is protected and can only be accessed to meet the child’s specific needs.

Turn your future payments into cash now

Other payment options for minors include a guardianship account (such as a money market account supervised by the court) or a structured trust (supervised by a trustee or financial advisor). Trusts can have tax benefits as well, but sometimes they reduce the settlement amount because fees are attached.

Designing Structured Settlements for Minors

Designing structured settlements for minors is a critical part of the settlement process. Federal and state laws assign courts the responsibility of determining both the fairness of the monetary settlement and how the awarded funds can be spent.

Courts seek to ensure:

  • The child will receive the money he or she is due
  • The money will grow over time
  • The money is protected from parents or guardians who might seek to use it for themselves
  • The child can’t spend the money all at once
  • The money lasts over time

If done right, the settlement plan will ensure the annuity income supports the child throughout their life by anticipating major financial needs at different ages.

The plan can be designed to provide for:

  • College tuition
  • Down payment or purchase of a car
  • Down payment or purchase of a house
  • Regular cost-of-living adjustments

There are several agencies that may receive and protect the settlement payments on the minor’s behalf. When designing the structured settlement, the court carefully evaluates every possible recipient to select the one that will protect the child’s best interest until they reach age 18 and can manage the structured settlement on their own.

Payments may be made to:

  • The Registry of the Court
  • A court-restricted bank account
  • A trust fund
  • An appointed guardian
  • A custodian under the Uniform Transfer to Minors Act

Structured Settlements Versus 529 Plans

As an alternative to structured settlements, some families may consider putting their financial award into a 529 plan for their minor. Developed in 1996 as section 529 of the Internal Revenue Code, a 529 plan is an educational savings account. Similar to a 401(k) retirement plan, 529s invest a person’s contributions into a mutual fund with the expectation of long-term growth. States and educational institutions administer 529 plans.

Although 529s do offer some advantages to those hoping to save money for a minor’s college education, this type of plan is disadvantageous when compared to a structured settlement for many reasons.

Disadvantages of 529 plans include:

  • Contributions to the 529 plan are not tax deductible, nor are they guaranteed.
  • Earnings can sometimes be subject to state tax when withdrawn.
  • Funds can only be used for approved educational purposes.
  • Funds used for disapproved educational purposes, such as a private tutor or trade school tuition, are subject to penalties.
  • The success of a 529 is based on the mutual fund it is invested in. If the market does poorly, the fund could decrease in value.

Comparatively, a structured settlement is guaranteed and tax-free. Funds can be used for expenses other than educational services, and continuous payment is guaranteed, regardless of the financial state of the payee. If the minor chooses to, they may also sell their future payments for a lump-sum of cash once they reach the age of majority, to pay for tuition or other expenses upfront.



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