Pros and Cons of Structured Settlements

A structured settlement is a financial agreement where an individual receives periodic distributions over time as compensation instead of a one-time lump sum payment. It often results from a negotiated resolution between the claimant and the defendant (or annuity from an insurance company) in a personal injury lawsuit.

When Are Structured Settlements Common?

Structured settlements are commonly used in various legal cases, such as the following.

Personal Injury and Structured Settlements

Personal injury pertains to any harm caused to an individual due to someone else’s negligence or intentional act. This can range from car accidents, slip and fall incidents, product malfunctions, and intentional harm like assault.

In personal injury cases, victims might have long-term medical expenses, therapy costs, or loss of earning capacity. Structured settlements offer victims a steady stream of income to cover these recurring expenses without the burden of managing a large sum of money all at once.

Workers’ Compensation and Structured Settlements

Workers’ compensation is a form of insurance that provides wage replacement and medical benefits to employees injured in the course of employment.

Workers’ compensation claims often involve long-term medical care or rehabilitation. A structured settlement can ensure that the injured worker receives regular payments to cover medical expenses, therapy, and any lost wages, especially if they’re unable to return to work or find suitable employment.

Medical Malpractice and Structured Settlements

Medical malpractice occurs when a healthcare provider, through a negligent act or omission, causes injury or harm to a patient. This can stem from errors in diagnosis, treatment, aftercare, or health management.

Victims of medical malpractice might need prolonged medical care, corrective surgeries, or therapy. The long-term nature of these expenses makes structured settlements appealing. By receiving periodic payments, victims can manage ongoing medical costs, lost wages, and other damages.

Wrongful Death and Structured Settlements

Wrongful death refers to a lawsuit brought by the family members or beneficiaries of someone who died due to the negligence or misconduct of another person or entity.

The loss from wrongful death goes beyond just immediate funeral costs. There’s the loss of future earnings of the deceased, potential inheritance, and even non-economic losses like companionship. A structured settlement can provide the deceased’s family with a consistent financial buffer over an extended period, easing some of the burdens caused by their loss.

In all these scenarios, structured settlements act as a financial safety net, ensuring that victims or their families have a consistent and predictable source of income to address the long-term consequences of their grievances.

Important Tax Considerations with Structured Settlements

Structured settlements are designed to provide compensation for injuries or losses over an extended period. To achieve this, the underlying principal (the amount that represents the compensation) is typically invested so it can produce a return or interest, ensuring that the settlement funds are sufficient to cover the periodic payments promised to the injured party.

Here’s how it works and the associated tax implications.

1. Interest Accumulation

When a structured settlement is established, a significant portion of the settlement fund is invested, often in annuities or U.S. Treasury securities. The principal amount earns interest over time.

2. Taxation of Interest

The original settlement amount (the principal) for personal injury, workers’ compensation, and similar claims are generally tax-free under U.S. federal tax law. However, the interest earned on that principal may be subject to taxation.

Example: If a person is awarded a $500,000 structured settlement, this principal amount is tax-free. However, if, over the course of several years, this amount earns $50,000 in interest, the $50,000 may be considered taxable income.

3. What to Do About It

• Awareness: Be aware of the potential tax liability. It’s essential to know that while the primary amount may be tax-free, the interest might not be.
• Tax Planning: Engage in tax planning. Understanding potential tax liabilities can help structure investments or other financial decisions more effectively.
• Consult Professionals: Always consult with a tax professional or financial advisor. They can offer guidance on how to minimize tax obligations or how to handle them when tax season comes around.
• Keep Detailed Records: Ensure you maintain detailed records of every payment received and the breakdown of principal vs. interest. This will make tax filing easier and more accurate.
• Potential Tax Deductions: In some cases, there might be related expenses that can be deducted against the interest income. For example, if there are medical expenses directly related to the injury, they might be deductible.

In summary, while structured settlements offer significant benefits, it’s wise to understand the potential tax implications of any interest earned. Proper planning and consultation can help you with these implications effectively.

Do Structured Settlements Offer Better Flexibility?

Yes and no. On the one hand, during the negotiation phase, the terms of payments – their frequency, amount, and duration – can be tailored to meet the needs of the claimant. On the other hand, once the agreement is finalized, it’s often challenging to modify, limiting financial flexibility in the future.

Do Structured Settlements Offer Better Financial Security?

In many cases, yes. Structured settlements provide a steady stream of income over time, reducing the risk of mismanaging a large sum of money. This can be especially beneficial for minors or individuals who might not have the means or experience to handle a significant influx of cash.

What Are Some Disadvantages of Structured Settlements?

Here are some disadvantages of structured settlements.

Lack of Immediate Access

Structured settlements are designed to provide steady, long-term financial support. However, this design also means that claimants won’t have instant access to the entirety of their awarded funds. This can be particularly challenging in situations where large, upfront expenses arise post-settlement.

For example, if a claimant suddenly needs a major medical procedure, a home modification, or any other significant expense, they might find the periodic payments from the structured settlement insufficient. This lack of liquidity can sometimes force claimants into seeking ways to “cash out” their settlements early, often at a discounted value, which can be financially disadvantageous.

Fixed Payments

The steady nature of structured settlements provides predictability, but the downside is that these payments are usually fixed and don’t adjust for changing financial circumstances or inflation. As the years go by, the purchasing power of fixed payments can erode, especially in high-inflation environments. This means that what initially seemed like a substantial monthly or annual payment may not cover the same ground in 10 or 20 years.

Additionally, life is unpredictable, and unexpected financial needs can arise. In such scenarios, the rigidity of fixed payments can be limiting, potentially leaving claimants financially strained.

Perceived Value

Perception plays a significant role in how we value our assets and income. Over time, as the structured settlement payments trickle in, recipients might start comparing their financial situation to hypothetical scenarios. They may wonder, “What if I had taken the lump sum and invested it?”

Depending on market conditions and investment opportunities, it’s possible that investing a lump sum might have yielded a higher total return than the cumulative payments of a structured settlement. This perceived opportunity cost can lead to feelings of regret or dissatisfaction, even if the structured settlement was, in reality, the best choice given the claimant’s circumstances at the time of the agreement.

What Are the Advantages of a Lump Sum Settlement?

• Immediate Access: Provides flexibility in using the entire amount as needed.
• Investment Opportunities: Beneficiaries can invest the amount to potentially grow their funds.
• Debt Clearance: It’s easier to settle significant debts or make substantial purchases.

Seeking Help from an Attorney for a Structured Settlement

An experienced financial lawyer can guide you through the negotiation process and help you decide between a structured settlement and a lump sum, depending on your individual needs and circumstances.

Looking for an attorney? Connect with one through LegalMatch today.