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Jury trial

A structured settlement is designed to compensate individuals following the outcome of a civil lawsuit. For example, if you were involved in a car accident and were seriously injured, you may choose to sue the driver who was responsible. If the court finds in your favor, you may be awarded compensation. Rather than making a lump sum payment, the defendant may negotiate a structured settlement instead. If you’re on the receiving end of a structured settlement or soon will be, it’s important to understand how they work. Before deciding how to handle a large sum of money that you’ve suddenly acquired consult with a financial advisor about the best way to handle it.

What Is a Structured Settlement?

A structured settlement is a payment arrangement that can result from a civil lawsuit, in which a plaintiff sues a defendant seeking damages. Structured settlements allow the defendant to compensate the plaintiff without paying a single lump sum of money all at once.

Structured settlements are voluntary, which means both the plaintiff and the defendant have to agree to it. Both parties can work together to come to an agreement or the structured settlement may be ordered by the court. This agreement can happen once a judgment is entered but defendants can also broach the subject of a structured settlement to avoid having a civil case go to trial.

This type of compensation arrangement may be offered in a number of situations, though typically, they’re used when a plaintiff has suffered some type of debilitating injury. For example, structured settlements may be used to resolve personal injury claims involving:

  • Car accidents
  • Motorcycle accidents
  • Dog bites
  • Workplace accidents
  • Slip and fall accidents
  • Accidental burns
  • Medical malpractice
  • Pharmaceutical injuries (i.e. drug side effects)
  • Negligence
  • Wrongful death
  • Class-action lawsuits

Structured settlements provide tax-free payments to injury victims or their families. This money can be used to pay for lifetime medical expenses and care or to replace lost income if the person who was injured is no longer able to work or has passed away as a result of the injury.

How a Structured Settlement Works

car wreck

Generally, a structured settlement agreement accompanies a civil lawsuit. So a plaintiff would first need to file a claim against a defendant in civil court. Once the defendant is served notice of the claim, they may attempt to negotiate a structured settlement before it goes to trial. Or they may allow the case to proceed and offer a structured settlement only when a judgment is entered against them and they’re required to pay money to the plaintiff.

A qualified assignee can work with both the defendant and the plaintiff to negotiate the terms of the structured settlement. Specifically, both sides will need to agree on:

  • How much the payments will be
  • How many payments the plaintiff will receive
  • Whether the payments may increase at any time
  • Whether any supplemental payments will be made

This can take time, as there may be disagreement about what constitutes a fair settlement. But once the terms are agreed upon, the defendant then provides funding for an annuity. This annuity is where structured settlement payments come from. In other words, the defendant doesn’t make payments to the plaintiff directly.

The qualified assignee will take the money provided by the defendant and purchase an annuity contract. Annuity contracts are sold by insurance companies and in addition to structured settlements, they can also be used to generate additional streams of income in retirement.

Once the annuity is in place, the plaintiff will receive payments from it according to the agreed-upon schedule. Those payments are tax-free for the plaintiff who can use them to pay for medical expenses, daily living expenses or any other expenses as they see fit.

Pros of Structured Settlements

Structured settlement agreements can be beneficial for individuals who are on the receiving end of these payments. Again, this is tax-free compensation so you don’t have to worry about payments affecting your tax liability. And if you’ve named a beneficiary for a structured settlement annuity, that individual could continue receiving tax-free payments after you pass away.

Aside from that, structured settlements can also offer these advantages:

  • Annuity payments can be tailored to fit the recipient’s lifestyle and needs.
  • It may be possible to negotiate settlement terms that allow for lump payouts in the future or an increase in benefits over time.
  • Receiving structured payments can make it easier to manage recurring medical expenses or other costs associated with an injury.
  • Payments from a structured settlement are guaranteed and earn interest over time.

It’s possible that you may receive more from a structured settlement than you could through a lump sum payout when interest is factored in. While a lump sum may be attractive, there may be a temptation to spend the money unwisely. And even if you choose to invest it, you still run the risk of losing money if those investments don’t pay off.

Cons of Structured Settlements

While there are some benefits associated with taking a structured settlement, there are some potential drawbacks to consider. Here are some important considerations to be aware of:

  • Any punitive damages or recompense for attorney’s fees that you’re paid outside of a structured settlement may be taxable to you.
  • Structured settlement terms are usually unchangeable once they’re finalized, meaning you have little flexibility if the original payment terms are no longer ideal.
  • You could sell a structured settlement annuity for cash but that means you no longer have the right to receive those payments going forward.
  • Withdrawing money from a structured settlement prematurely could result in tax penalties and you may also pay surrender fees.

If you expect to receive a structured settlement, it’s important to consider the terms you’re agreeing to before signing anything. This way, you have time to make a request or change to the agreement before it takes effect. Also, consider whether a structured settlement is the best solution for meeting your financial needs in the near and long term versus receiving a lump sum payout. Staying in close communication with your attorney can help with decision-making as you approach the resolution of a civil case.

Bottom Line

Woman who just got a structured settlement

Structured settlements are used to compensate people who have been injured or harmed in some way through no fault of their own. This type of annuity can generate a steady stream of tax-free income which can be used to pay medical bills or other expenses. Before agreeing to a structured settlement as part of a civil lawsuit, it’s important to read through the fine print carefully.

Financial Planning Tips

  • Consider talking to a financial advisor about the best way to manage structured settlement payments if you’re receiving them. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor, get started now.
  • When receiving structured settlement payments, it’s important to think about how to use those funds to your advantage. If the original injury you suffered has healed, for example, and you no longer need that money to pay medical bills you may consider using it for another purpose. That could include investing it to build wealth or transferring those funds to a trust on behalf of your children or other beneficiaries.

Photo credit: ©iStock.com/Image Source, ©iStock.com/SoCalShooter, ©iStock.com/Deepak Sethi

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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