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A structured settlement refers to payments that result from a lawsuit and/or accident case. If an individual is (or was) involved in a successful lawsuit, their experience with structures could be a complicated and personal matter. Structured settlements certainly serve a purpose, and for those involved in an injury suit, they may provide a much-needed sense of security and financial well-being. If a person has suffered an injury and received a structured settlement, or is currently evaluating one, there are some aspects that should be considered about these agreements and whether a person should have opted for a cash payout. There are reasons that exist for both options and the details should be explored thoroughly before a decision is made.
Even if the injured party has already accepted a structured settlement offer, they may not be aware of how such an agreement operates and why they are set up in the way they are. Not surprisingly, structured settlements are set up in the fashion they are mostly because of tax reasons.
For instance, if someone is injured in a car accident and they receive a lump sum $500,000 cash payout from the insurance company or other driver, that settlement money is viewed as tax-free. However, if and/or when they invest that settlement money or some portion of it, the investment earnings that result are considered taxable income. Yet, if the injured party receives a structured settlement instead of a lump sum payout, they will receive payments over a period of time or even a lifetime (depending on the settlement terms), and each payment received is viewed as tax-free. Thus, a structured settlement converts any after-tax earnings into a tax-free return.
Structured settlement brokers, which are specialty insurance agents, are brought in as consultants when such an agreement nears completion. These specially trained and licensed brokers are paid standardized commission fees via the insurance company that issues the annuity to the injured party(ies). The brokers employed to construct the settlement can run a variety of financial projections based numerous scenarios. The structured settlement could be based on payments over a person’s projected lifespan, a specific period of time, over the injured party’s and their spouse’s joint lifetimes, etc. Moreover, an individual could choose to suspend payments for a specified period of time (e.g. 10, 15, or 20 years) and opt to resume payments later on in life as a way to fund their senior years or retirement.
As demonstrated, structured settlements are very flexible and varied in nature. However, there are many details to explore and reasons to consider converting to cash before signing any settlement agreement in an injury case. Ideally, these agreements allow the recipient to construct their payments as high or low as they desire and take the remainder in cash. Nonetheless, these settlements must be set up properly in order to benefit and protect the beneficiary.
Case in point, a person cannot “own” the annuity policy that is issued via the structured settlement agreement. This is because the tax-free benefits would not apply to the injured party if the policy was held by the beneficiary. As a result, instead of paying a cash settlement to the injured party or their lawyer, the defendant/insurance company sends the money stipulated in the agreement to a life insurance company’s subsidiary, which is referred to as an assignment company. This assignment company purchased the annuity from its parent life insurance company, and it holds the policy while disbursing payments to the injured party, as dictated under the terms of the agreement.
These structured settlements are allowed via special provisions under the U.S. tax code. Aside from the special benefits allotted to insurance companies, this arrangement allows the injured party to be a recipient of the periodic payments over time. Therefore, they are guaranteed to receive each payment promised under the agreement; however, the IRS does not classify them as an owner. Thus, because the injured person does not own anything except an expectation of each payment, it releases them from tax liability associated with payment ownership.
While structured settlements have many advantages, such as asset protection, tax advantages, protection for beneficiaries from spending a settlement too quickly, etc., they are not designed for everyone. There are many details to explore and reasons to consider converting to cash before a decision is made. Moreover, once these agreements are set up, they generally cannot be restructured or altered without court intervention.
There are also reasons to consider converting a structured settlement into cash. Here are five reasons a person might consider converting a structured settlement into cash.
1. Circumstances Change–Someone had an accident many years ago and received a settlement in the form of an annuity to ensure continued financial support for their future needs. However, in the meantime, the person’s circumstances have changed. Currently, they might have mounting debt, medical bills, a loss of job or income, and/or unforeseen large expenses have jeopardized their financial well-being. As a result, the recipient has found themselves in dire financial straits. They need cash now and there are factoring companies that will buy up structured settlements (or a portion of the settlement) at a reduced rate from accident victims who are in need of cash payouts. However, it is important to note that most states now require a court hearing before a structured settlement can be purchased or altered in any way.
2. Terminal Illness–If a person has a terminal illness or serious health concerns, it could be in their best interest to convert their agreement into cash. This is especially true if their settlement is set up over many years or a person’s expected lifespan and they will not survive long enough to receive full compensation. A person might need to cover their debts and end-of-life expenses, want to spend their remaining time touring the globe, have a bucket list to complete, or maybe their family needs some financial stability and peace of mind. In these circumstances, converting a structured settlement into cash could make a lot of sense.
3. The Cost of Inflation–The terms and/or monthly payments stipulated in such an agreement may no longer cover a recipient’s bills or expenses. Over time, inflation could eat away at the dollar value of the structured payments. Thus, the cost of inflation could factor into a person’s decision to convert their structured settlement into cash.
4. Entrepreneurship–Maybe someone has aspirations to, but cannot secure a business loan or investors for their venture. Cashing in a structured settlement for start-up capital could be an option. Keep in mind that such a crucial decision should consider the big picture and future fallout, such as the loss of asset value resulting from the sale of the agreement. For instance, in most cases, the injured party will only receive about half the actual value of their structured settlement if it is converted to cash. This is especially true when dealing with third-party factoring companies who offer fast cash quickly for a structured settlement.
5. Investment Opportunities–Some may want to convert a settlement agreement into cash to pursue other investment opportunities, such as high-yield bonds, mutual funds, real estate, or the stock market, with hopes of garnering a better return on their money and improving their future prospects.
While structured settlements have many advantages, such as asset protection, tax advantages, and protection for beneficiaries from spending a settlement too quickly, they are not designed for everyone. There are many details to explore and reasons to consider converting to cash before a decision is made. If someone is considering converting their structured settlement for cash, there are several companies willing to purchase settlement agreements and offer cash payouts. However, it is important to keep in mind that securing a lump sum cash payout for structured settlement payments can be very complicated and financial risky business. There are many aspects to consider before going through with such an arrangement. Namely, recipients can realistically expect to receive only about half the actual long-term value of their structured settlement (or less) if they convert it to cash, so they should have very good reasons for cashing in and it should be viewed as a last resort option for any financial hardships affecting their life.
By Leigh Haugh
Forbes–What’s a “Structured Settlement”?
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Bankrate–Want Settlement Cash Now? Not So Fast!
Injury Claim Coach–Purchase Settlement Payment: Pros and Cons of Selling Structured Settlements