What Is a Structured Settlement?

Person with a broken leg, talking on the phone
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DEFINITION
Structured settlements are settlements given to injury victims that are periodic payments over time instead of a single lump-sum payment.

Structured settlements are long-term payment plans often awarded to injury victims who sue or plan to sue the responsible party. These types of settlements provide more flexibility and financial stability than lump-sum payments.

Learn more about how each structured settlement is tailored to meet the immediate and long-term needs of recipients.

Definition and Examples of a Structured Settlement

Structured settlements are settlements given to injury victims that are periodic payments over time instead of a single lump-sum payment. Typically, a structured settlement compensates a recipient through an annuity funded by the responsible party and issued by a life insurance company.

  • Alternate name: Disability payments

For example, if you lose a finger on the job and sue your employer, a court may award you $500,000 in compensatory damages. Instead of a lump-sum payment of $500,000, however, you and your employer may decide to settle the award through a structured settlement that pays you $25,000 per year, for 20 years.

Structured settlements allow for personalization to cover future medical costs, adjust for inflation, and pay family expenses. For instance, if you have a prosthesis that needs replacing every five years, you can design a structured settlement that pays a higher sum every fifth year.

How Does a Structured Settlement Work?

The federal Periodic Payment Settlement Act of 1982 established structured settlements. Traditionally, injury victims received settlements or court awards in a single, lump-sum payment. However, structured settlements pay over time through periodic payments.

For example, if a factory worker sustains a disabling injury on the job due to faulty equipment, they could sue their employer for, say, $1 million. Or the employer and employee could agree on a structured settlement that would pay the employee $50,000 per year, for 20 years.

Structured settlements help recipients avoid spending a settlement too quickly, which could diminish long-term financial stability following a debilitating injury.

Negotiating a Structured Settlement

Structured settlement terms are typically determined in private between the parties either before, during, or after a lawsuit filing, or by a court. Negotiations may focus on a variety of issues, which can include the injured person’s medical needs, living expenses, and family needs. Often, one or both parties will hire a structured settlement broker, an expert who determines long-term financial needs.

Once a plaintiff and defendant reach an agreement, the defendant must set up a funding vehicle, typically an annuity. The recipient will then start receiving periodic payments according to the settlement terms. Structured settlements are flexible, allowing the parties to design payments based on expected needs, which may require occasional larger payments, to periodically replace a wheelchair, for example.

Structured settlements pay annually, semi-annually, quarterly, or monthly, depending on the agreement reached between the parties.

Structured Settlement Taxation

Structured settlements provide continuing payments for injury victims, helping them avoid the need for public assistance. For that reason, proceeds from structured settlements, including earnings, are tax exempt.

Structured Settlement Transferability

In the early 1990s, finance companies devised schemes to buy structured settlements. Commonly called “factoring” companies, these enterprises pay a small lump sum to recipients and require them to redirect payments to the companies.

In some cases, factoring companies reassigned structured settlement payments without informing the companies that issued the annuities. To combat the exploitation of injury victims, state legislatures began passing laws to regulate transferability of structured settlements.

Virginia is one of many states that require court approval to reassign payments of a structured settlement.

Types of Structured Settlement Annuities

The market offers several types of structured settlement annuities:

Cash Refund

The annuity company continues to make payments to the recipient as long as the recipient is alive, even if the sum of the payments exceeds the premiums paid. If the recipient dies before the payments received equal the premiums paid, the annuity company pays the remainder of funds to the contract owner in a lump sum.

Installment Refund

The annuity provider continues to make payments as long as the recipient is alive. If the recipient dies before receiving payments equal to the premiums paid, the annuity company pays remaining premiums to the contract owner in installments.

Life With Period Certain

This pays the recipient as long as they are living or for a specific period, whichever is longer. For instance, if an annuity pays for 25 years but the recipient dies after the first year, it will continue to pay for 24 more years. But if the recipient outlives the 25-year payment period, the annuity will continue to pay until they die.

Period Certain

Only pays for a specific period. For example, an annuity may make annuitized payments for 25 years, after which, payments would stop.

Life Only

The annuity provides annuitized payments and is paid only while the recipient is alive.

Pros and Cons of Structured Settlements

Pros
  • Flexible payment distribution

  • Long-term financial security

  • Tax-free

Cons
  • Annuity fees

  • Annuity terms aren’t changeable

  • Lump-sum-only payments aren’t available

  • Punitive damages are taxable

Pros Explained

  • Flexible payment distribution: Payment schedules are tailored to meet a recipient’s needs. For example, if you’re injured and have young children, you can request larger payments for the first few years to cover your kids’ education costs.
  • Long-term financial security: Unlike a lump-sum payment, structured settlements can provide income for many years, depending on the settlement’s terms. Payments can cover lost income, medical costs, and family expenses.
  • Tax-free: Proceeds from a structured settlement are not taxable.

Cons Explained

  • Annuity fees: An annuity may charge an annual administrative fee and impose other charges, such as funds transfer fees for changing investment options.
  • Annuity terms aren’t changeable: Once the structured settlement negotiation is complete and an annuity is in place, you can’t change the terms of the agreement. For instance, if your structured settlement pays $5,000 per month for 20 years, you can’t change the payout to $10,000 per month for 10 years.
  • Lump-sum-only payments aren’t available: If you choose a structured settlement and begin periodic payments, you can’t receive a lump sum later. However, you can negotiate a structured settlement that pays periodic payments for a specific period, plus a lump sum at the beginning of the period.
  • Punitive damages are taxable: The compensatory damages paid through a structured settlement are tax-free. However, the IRS considers punitive damage awards as taxable income.

Key Takeaways

  • Structured settlements compensate injury victims in a flexible manner, allowing recipients to receive payments annually, semi-annually, quarterly, or monthly.
  • Instead of a lump-sum payment, structured settlements offer tax-free periodic payments.
  • Most structured settlements pay recipients through annuities.

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