A structured settlement, also known as an annuity, is a legally agreed-upon financial or insurance agreement through which a claimant settles a wrongful death tort claim in which the defendant agrees to settle the claim by paying a specified amount of money over a certain period of time, either as a lump sum or via periodic payments. The structured settlement may be structured through an insurance policy. It may also be structured through an agreement between an insurer and the claimant’s insurance company. A structured settlement usually takes the form of a court-ordered financial plan, which is often used as part of a structured settlement in exchange for the claimant not pursuing a claim in court. If the structured settlement were an annuity, the payments would be made to the claimant on a regular schedule.
Structured settlements are considered tax-free payments because they are paid to the defendant under a court-approved contract. This contract must provide for regular and ongoing payments that take into account factors such as current and future economic conditions, the life expectancy of the claimant, the length of time involved in settling the case, and other relevant considerations. If future annuities are payable to an individual, the details of the payment process are often spelled out in a legal agreement between the parties. In some cases, the payee may be taxed on the tax-free payments that exceed the total amount of structured settlements, resulting in taxable income to the claimant.
How Does a Structured Settlement Work?
Structured settlements are fairly easy to understand. Basically, those in need of money can agree to the structured settlement themselves, or they can be forced to cash out the cash if they lose the suit in court. If the agreed amount of cash is substantial enough. The wronged party can have the option of getting a single lump sum settlement, rather than having to make monthly payments. But what is the actual arrangement with these settlements? Why do so many people get them and what are the advantages?
Single Payment
The lump-sum distribution of a structured settlement is actually considered tax-free because it’s received as a single payment from an annuity provider. That annuity may come from one’s life insurance or other savings account, as long as it’s not subject to taxation. The money will go out free, but any taxes you may owe will only be the total of the interest and administrative fees. You may also have been taxed on the entire life of the annuity, so be sure to take this into account when computing your taxes.
Incremental Payments
In addition to receiving a one-time-only lump sum, some individuals who obtain structured settlements also have the ability to receive incremental payments over time. For example, in some cases, a claim may be approved and the plaintiff may receive small awards over time. However, in some cases, the claim may move slowly, with smaller awards given at first, and large awards later. These increments are called payout options. Sometimes there are even companies that allow for cumulative payments instead of the incremental type.
When comparing these financial products, you’ll find that there are several different types of settlements. Some are known as structured settlements that feature both a lump sum and periodic payments. Others are known as annuities. One that is sometimes confusing is the hybrid structured settlement annuity.
Civil Case
A civil case involves a plaintiff and a defendant. In a civil case, the plaintiff, usually a person who has suffered an injury, brings suit against the other party to seek compensation for medical expenses, lost wages, pain, and suffering, etc. The defendant is then sued by the plaintiff for their negligence. In most states, there are exceptions to these rules. They may permit the defendant to use a structured settlement to settle the case out of court if the plaintiff is unable to continue with the lawsuit. This is often seen in personal injury cases in which the victim might live away from the area in which the medical expenses are located.
Annuity
A structured settlement can also be referred to as an annuity. An annuity is a contract under which a fixed amount of money is paid out over time. For instance, the purchaser of a house, on the agreed terms, will make monthly payments for a certain number of years. The same holds true for a lawsuit settlement; payments made to the defendant are broken up and dispersed over time. It is like an insurance policy that pays out over time; however, those payments may vary greatly.
Structured settlements work best when the plaintiff does not want to risk losing any of the future payments he or she might receive. Most plaintiffs would prefer to have something to fall back upon in the event that they lost their case. With structured settlements, they have the option of selling the remaining future payments to a third party. However, it is important to remember that if the remaining payments are not sold. The settlement beneficiary, the party paying out the payments, does not lose anything.
Even though structured settlement payments can benefit anyone. They work especially well for individuals who win major lawsuits that have long durations. For example, a person who has won a personal injury lawsuit may be entitled to payments for a decade or more, depending on the length of the case. However, if that same individual were to stop making payments, he or she could find herself in serious financial trouble. That’s why it is much better for plaintiffs to use their settlement money for things such as education, medical bills, or taking a vacation rather than having the money tied up in a lawsuit. Structured settlement payments may not always work for everyone, but they provide a great source of income and peace of mind.
Pros and Cons of Structured Settlement Loans
A structured settlement is an agreed-upon stream of income tax-free payments awarded to the plaintiff in an injury lawsuit. When the suit is settled, there are several options that can be offered to the individual who received the award. Those involved in the lawsuit may agree to a structured settlement on their own accord, or they might be compelled to pay out the money if they lose the case at court. The money that is paid out may be paid at a fixed rate over time or it might come in a lump sum. Either way, it is considered a periodic income and is subject to taxation.
A lump-sum payment from a company that collects taxes on behalf of the recipient will be taxed as regular income. Some recipients will not be able to take advantage of this option. Others may want to use the lump sum for other things such as home equity loans or an inheritance. A tax-deferred annuity is also available for those people who want a lump sum but who do not qualify for a structured settlement.
Tax-deferred Annuity
A tax-deferred annuity is similar to a structured settlement in that it is an agreement between the insurer and the recipient. The only difference is that the annuity is not taxable and cannot be sold. The lump-sum obtained through selling structured settlements instead of tax-deferred annuities is used to buy an annuity or some type of fund that provides a steady source of income. When the individual reaches a certain age. They have the option to convert their annuity into a tax-deferred annuity and receive a higher level of income.
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Many plaintiffs are concerned about the long-term implications of what is known as a structured settlement payout. They worry about whether they will be able to pay their bills and contribute to their children’s college education. This concern is well-founded. One reason why the payout cannot be sold to an individual or entity, immediately is that the federal government taxes payments made to individuals based on when they are actually received. If the victim of the lawsuit becomes unemployed, they cannot claim the payout until they find employment. This could mean a two or three-year wait.
Personal Injury Cases
When lump-sum payment plans are made to victims of personal injury cases, the government taxes the entire lump sum received. In most states, structured settlements are treated as income by the recipient and are therefore taxable. If the victim were to sell their structured settlements for a lump sum amount, it would be subject to state taxation. In most states, structured settlements are excluded from taxation if the recipient is not eligible for income tax benefits based on their work history.
Some lawyers who represent plaintiffs in personal injury cases advise against selling structured settlement payments. They state that the recipient of these payments could face exploitation which could have serious financial consequences. For this reason, they advise recipients to wait to receive the full amount of the settlement until they are able to financially support themselves.
Tax-Free Settlement Payments
While tax-free settlement payments may not always be taxable, some states do assess tax on any monies received from structured settlements. It is important to consult with a certified public accountant or tax lawyer prior to having any discussions about putting any money into a structured settlement. This is especially true if the recipient’s future plans include a career in academia or government service were receiving a tax-free pension is quite likely. If the recipient does not intend to work after receiving a settlement, it may not make sense to invest in such a large tax burden.
Final Verdict
Structured settlement loans are not for everyone. Only a small percentage of plaintiffs who use them ever face the possibility of exploitation. The best approach is to only seek a settlement if you face no other alternative. You will not receive as much as you would without the loan. And you may not be able to obtain the most favorable terms on the loan. Structured settlement loans can be an ideal way for those facing financial hardship to retain their home and avoid foreclosure. As with all financial decisions, it is wise to talk to a lawyer before signing any contract.
