WHY STRUCTURED SETTLEMENTS?
WHY SHOULD YOU CONSIDER A STRUCTURED SETTLEMENT?
Your attorney may have suggested that the settlement in your case be managed as a "structured settlement". If you're wondering about the details of this type of agreement, take a moment to read this information. It should answer many of the questions you might have.
1. WHAT IS A STRUCTURED SETTLEMENT?
A structured settlement is an agreement to settle a personal injury, wrongful death or environmental claim based on money to be paid upon settlement, together with the promise of future periodic payments specific as to amount and timing. What this means is that the plaintiff's claims are released in exchange for the promise by the defendant to make payments to the plaintiff. A structured settlement may or may not include an up front, immediate cash payment at settlement. It is assumed that all such structured settlement payments will be tax free to the plaintiff under section 104(a)(2) of the Internal Revenue Code.
2. WHAT ARE THE BENEFITS OF A STRUCTURED SETTLEMENT?
The benefit of a structured settlement to a plaintiff is that he/she can receive tax-free, secure, management-free, lifetime income that he/she can neither outlive nor prematurely dissipate. The benefit to the defense is the ability to settle a claim at a cost lower than a cash settlement.
3. WHAT ARE THE DISADVANTAGES OF A STRUCTURED SETTLEMENT?
For the plaintiff, the primary disadvantage is that once the payments are agreed upon, they cannot be changed. Thus, even if the plaintiff's financial needs change, the payments cannot be changed to address these needs. Unanticipated inflation will decrease the plaintiff's purchasing power. Interest rate increases and the risk of default are other disadvantages.
For the defendant or insurer, retaining the obligation to make the payments can be a disadvantage. This disadvantage arises if the life insurance company making the payments defaults. To avoid this, most defendants and casualty insurers assign the obligation to make the periodic payments to a third party (see also financial risks of a structured settlement).
4. WHAT ARE THE TAX ADVANTAGES OF A STRUCTURED SETTLEMENT?
A properly executed configured structured settlement will provide tax-free future payments to the plaintiff. Both the principal and accumulated interest can be excluded from the plaintiff's gross income, because the plaintiff does not own or control the funding asset. Plaintiffs in high tax brackets will enjoy greater tax benefits. However, if plaintiffs have sizable tax-deductible medical expenses, the structured settlement's potential tax savings may be greatly reduced.
5. WHAT ARE THE TWO PARTS OF A STRUCTURED SETTLEMENT?
A structured settlement consists of two component parts. The first component part is the upfront cash. The second part is the future payment stream. The purpose of a structured settlement is to prioritize the plaintiff's present and future financial needs within a current and future payment schedule.
Upfront cash is the cash that will be received immediately at the time of settlement.
For the plaintiff, the primary purpose of upfront cash is to:
cover existing liens (workers' compensation, medical, etc.)
past due household expenses (including funeral expenses in a wrongful death case)
past lost wages and fringe benefits
pain and suffering (partial or full)
contingent emergency medical expense fund
In addition, upfront cash may be used to provide for attorneys' fees. This can be either a partial or full payment of fees. It is very important for the attorney to make sure that the size of the upfront cash is sufficient to cover both the needs of the plaintiff and the amount of the attorneys' fees.
A Payment Stream is the schedule of payments the plaintiff will receive during the life-time of the structured settlement. The purpose of the future payment stream is to:
provide for future medical expenses
replace future lost wages and fringe benefits
replace lost future services (such as those of a homemaker)
compensate for future pain and suffering.
PAYMENT STREAMS FALL INTO THREE (3) CATEGORIES:
Life payment - these are payments that will continue for as long as the plaintiff is alive. The payments can be guaranteed (to the estate of the plaintiff) for a specific number of years and can have a cost of living annual adjustment (COLA). The frequency of the payments can range from weekly to annually.
Period payment - these are payments that will be limited to fixed and specific time period. They can be guaranteed or non-guaranteed and can have a cost of living annual adjustment (COLA). The frequency of the payments can range from weekly to annually.
Lump-Sum payment - this is a single, stand alone, isolated payment that is either guaranteed or un-guaranteed. A structured settlement can have a series of lump-sum payments as part of their entire payout schedule. A lump-sum payment does not have a COLA.
6. HOW DO INTEREST RATES AFFECT THE PAYMENTS FROM A STRUCTURED SETTLEMENT?
Basically, annuity payments rise or fall along with the increase or decrease in interest rates.
7. CAN A PLAINTIFF PURCHASE A STRUCTURED SETTLEMENT ANNUITY AND STILL GET PAYMENTS TAX-FREE?
No. Only a qualified settlement fund (468(b)(1)), the defendant, the insurer or an assignment company may purchase an annuity to fund a structured settlement.
8. CAN A PLAINTIFF KNOW THE COST OF THE STRUCTURED SETTLEMENT WITHOUT JEOPARDIZING THE TAX ADVANTAGES?
Yes. Knowing the cost of a structured settlement does not constitute constructive receipt. IRS Private Letter Ruling 83-33035 states that a plaintiff may know the cost of the structured settlement without endangering its tax-free nature.
9. HOW DOES A STRUCTURED SETTLEMENT ACHIEVE TAX-FREE PAYMENTS TO THE PLAINTIFF?
The settlement documents must conform to Revenue Ruling 79-220 and if there is an assignment, to Internal Revenue Code (IRC) § 130 as well. Then each payment will be tax free under IRC § 104(a)(2).
10. WHAT ARE THE FINANCIAL RISKS OF A STRUCTURED SETTLEMENT?
There are two major financial risks with a structured settlement, excluding currency risks (inflation, the collapse of the dollar, etc.). One risk is that the life insurance company issuing the annuity could become insolvent. The owner of the annuity and the payee bear this risk. The other risk is that the owner of the annuity may become insolvent (see also disadvantages of a structured settlement).
11. WHAT IS THE ROLE OF INSURANCE RATING SERVICES WHICH RATE LIFE INSURANCE COMPANIES?
Rating services give opinions on the financial strength of life insurance companies. These rating opinions provide valuable assistance when choosing a life insurer which issues the annuity.
12. WHAT ARE STATE LIFE INSURANCE GUARANTEE FUNDS?
Many states have legislated guarantee funds for life insurance products, including annuities. These funds may provide an extra level of protection should a life insurance company fail.
13. WHAT IS A "GUARANTEED" OR "CERTAIN" PAYMENT?
A "guaranteed" or "certain" payment (the terms are used interchangeably) will be made to the plaintiff while living and thereafter made to their heirs. In other words, the life insurance company must make the guaranteed payment on the due date whether or not the injured person is alive.