Structured Settlements 101: What Every Recipient Should Know

You’ve been the unfortunate victim of an accident or wrongdoing, and after going through the required steps, you are entitled to financial compensation. At this moment, you have two options: receive the entire lump sum in one payment or go with a structured settlement.

We’re here to tell you why, if the sum is large enough, it’s best to opt for a structured settlement.

Annuity vs. Lump Sum

As a rule of thumb, both parties (the plaintiff and the defendant) have a say in the lump-sum vs. annuity debate. It can be a decision between the parties or decided by the courts, but the plaintiff usually has the final say on whether to accept a settlement.

Conversely, a defendant cannot be forced to set up a structure if they just want to write one check and walk away. Also, in some states (such as New York and California), if the damages exceed a certain threshold (e.g., $250,000), the defendant has the right to request that the court structure the future-damages portion of the award.

In general, once a verdict has been reached, there will be a negotiation over how to handle the settlement. If you’re offered a structured settlement annuity, we recommend taking it.

Why Opt for an Annuity?

In simple terms, an annuity or a structured settlement means you will receive the sum you are entitled to over a period of time, as per the initial contractual agreement. Payments can be certain (guaranteed for a fixed period, regardless of whether the recipient lives) or life-contingent (paid only as long as the recipient is alive).

Now, here are a few good reasons why opting for a structure is better:

It’s Tax-Free

If you’re being compensated for a case of physical injury or sickness, the money you’re entitled to is 100% income tax-free, under IRC §104(a)(2). But there are a few stipulations to keep in mind: if you take a lump sum, only the initial check is tax-free.

If you take that $1M and put it in a high-yield savings account, the interest you earn every year is taxable. With an annuity, the initial amount plus all the growth/interest inside the annuity remains 100% tax-free.

You Can Sell It

The main reason to opt for a structured plan rather than a lump sum is the financial security it provides. But this doesn’t mean you are stuck with this arrangement if, midway through, you need the rest of the sum all at once.

You have the right to sell the settlement. You’re selling the legal right to receive future payments in exchange for a discounted lump sum (typically between 9% and 18%) of the remaining amount.

It’s best to make sure you’re fully informed on what taking this step means, so get yourself a reliable guide to selling your settlement before making any decisions.

You Can Save It for Retirement

Given the current economic climate, a structured settlement can be a private, tax-free pension, or at least part of your retirement plan. The thing many people don’t know about this type of financial arrangement is that the recipient doesn't have to start payments immediately.

In a deferred structure, the money can sit and grow inside the annuity for years (or decades) before the first check arrives. For instance, the event that triggers the settlement can happen when you’re 40, but you can structure the settlement to remain untouched until the age of 65.

As a nice added bonus, besides the sum you’re entitled to, you’ll also receive the interest that has compounded over the years. And, it may be tax-free if you fit the right category.

Structured Settlements for Financial Stability

Unless you have a well-defined plan, a large sum of money is difficult to manage. On the other hand, a structured settlement provides a guaranteed, lifelong financial floor that a lump sum simply cannot protect.