What Is a Structured Settlement and How Does It Work?
Understand structured settlements: their purpose, how they are established and managed, and the process for selling future payments.
A structured settlement provides a method for an injured party to receive compensation through a series of periodic payments, rather than a single upfront lump sum. This financial arrangement is established as part of a legal resolution, such as a personal injury claim, and is designed to provide long-term financial support. It offers a predictable income stream, which can be particularly beneficial for individuals with ongoing needs resulting from an injury.
Understanding Structured Settlements
A structured settlement is a financial agreement where a claimant resolves a damage claim by accepting a schedule of payments over time, rather than a single lump sum. This approach is frequently employed in legal contexts involving personal injury, wrongful death, or medical malpractice claims, where ongoing financial support is needed. Payments are generally funded by the defendant or their insurer through the purchase of an annuity from a life insurance company. This annuity guarantees the future payments to the claimant.
The parties involved typically include the claimant, who is the injured party receiving the payments, and the defendant or their insurer, who provides the compensation. An annuity issuer, usually a life insurance company, sells the annuity that funds the payments. An assignment company, often affiliated with the annuity issuer, may also be involved to assume the defendant’s obligation to make periodic payments, thereby transferring the liability.
A key characteristic of structured settlements arising from personal physical injury or sickness is their tax treatment. Under Internal Revenue Code Section 104, payments received from these types of structured settlements are generally exempt from federal and state income taxes. This tax-free status extends to both the principal amount and any interest or investment earnings generated within the annuity. This provides a notable financial advantage, allowing the recipient to utilize the full value of the payments without tax deductions.
Establishing a Structured Settlement
The process of establishing a structured settlement typically begins during the negotiation phase of a legal dispute, often stemming from a personal injury or wrongful death claim. Either the plaintiff or the defendant can propose a structured settlement to resolve the case. This voluntary agreement allows both parties to tailor the payment schedule to meet the claimant’s specific needs, such as covering long-term medical care or lost income.
Once the parties agree on the terms, formal legal documentation is prepared to solidify the structured settlement. The settlement agreement outlines the total compensation amount and the agreed-upon payment schedule. A qualified assignment agreement is crucial in “assigned cases,” where the defendant or their insurer transfers the obligation to make future payments to a third-party assignment company. This assignment company then ensures the periodic payments are made.
To fund the structured settlement, the defendant or their insurer purchases an annuity contract from a life insurance company. This annuity is a financial product designed to generate the agreed-upon series of periodic payments to the claimant. The funds provided by the defendant are used to acquire this annuity, which delivers the long-term compensation.
Managing Structured Settlement Payments
Once a structured settlement has been formally established and the annuity purchased, the recipient begins to receive payments according to the agreed-upon schedule. These payments are typically delivered through methods such as direct deposit into a bank account or via mailed checks. The frequency of payments can vary, often structured to meet the recipient’s specific financial needs, including monthly, quarterly, semi-annual, or annual disbursements. Some arrangements may also include lump sum distributions at predetermined future dates, such as for college tuition or other significant expenses.
The payment schedule, once set, is generally fixed and cannot be easily altered by the recipient. This lack of flexibility is an inherent characteristic of structured settlements, designed to provide a predictable and consistent income stream over the long term. While the initial structuring offers considerable customization, the terms become legally binding once the agreement is finalized and the annuity is funded. Recipients should carefully consider their future financial requirements during the negotiation phase, as significant changes to the payout schedule are rare once payments commence.
The stability of these payments is a core feature, as they are not subject to market fluctuations. The underlying annuity guarantees the payments, providing financial security to the recipient. While structured settlements offer a secure and steady income, this fixed nature means the recipient cannot readily access a large sum of money for unforeseen emergencies or immediate expenses beyond the scheduled payments.
Selling Structured Settlements
Recipients of structured settlements may sell their future payment rights for an immediate lump sum. This process involves a specialized financial entity known as a factoring company, or structured settlement purchasing company. The factoring company acquires the rights to some or all of the future periodic payments from the original recipient in exchange for a discounted one-time payment. This provides the recipient with immediate access to a larger sum of cash, which can be used for various purposes like unexpected medical bills or significant investments.
A legal requirement for selling structured settlement payments is obtaining court approval. Federal and state laws, often referred to as Structured Settlement Protection Acts, mandate judicial oversight to protect the claimant’s interests. This approval process typically involves a court hearing where a judge reviews the proposed sale to ensure it is in the “best interest” of the payee, considering their welfare and that of any dependents.
The concept of “discounting” is central to the sale of structured settlement payments. The lump sum received by the seller is less than the total sum of the future payments they are relinquishing. This difference, known as the discount, represents the factoring company’s profit and compensation for the risk and time value of money. The court’s role includes evaluating whether this discount is fair and reasonable, given the circumstances, to protect the seller from unfavorable terms.