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structured settlements questions

Updated on August 20, 2007

What are structured settlements?

Before we can understand what a structured settlement is, we have to understand what other types of settlements there are. When an individual becomes a claiment in a personal injury action, that individual must take into account any future earnings that they may be losing out on as a result of their injury. They must also take into account any future expenses their injury may incur in the form of medical bills or other important care. There are three types of settlements, which are:

  • Lump Sum Payment
  • Structured Settlements
  • A combination of Structured Settlements and Managed Investment

The above three settlements have some important differences. In particular, the areas of taxation and inflation protection. The differences may effect the ammount a claiment recieves in a settlement.

Lump Sum Settlements

Lump sum settlements occur when a one-time payment is recieved to cover all future expensives and/or loss of earnings. The key idea behind a lump sum settlement trusts that the claiment will responsibly handle all future expenses and investments responsibly. Lump sum payments are often recommended to those in low tax brackets, and/or those who have personal experience with investments. A lump sum has several advantages, as well as several disadvantages.

Lump Sum Advantages

  • A quick and easy settlement method
  • Several different investment options
  • Easy access to money

Lump Sum Disadvantages

  • Any investment income is taxed
  • Performance of investment risk
  • Investment timing risk
  • Possibility of running out of funds before death
  • Management fees
  • Risk of inflation

Structured Settlements

Structured Settlements are a periodic payment of compensation method that covers claiments for loss of earnings, future care costs, general damges, and wrongful death.

As is most commonly the case, the payments are designed to help meet the claiments needs. Generally, payments are made on a monthly bases to help a claiment meet regular expenses. A structured Settlement can also include lump sum payments in order to take care of large financial requirements. Structured Settlement payments are made by the insurance company, or the defendant, through the purchase of an annuity contract under which all payments are directed towards the claiment. It is the responsibility of the insurers to ensure a claiment recieves their payments, or the insurer must arrange for another party to do so.

There are some important differences between lump sum settlements and Structured Settlements (in particular, Structured Settlements are tax-free), as well as some advantages and dissadvantages with Structured Settlements.

Structured Settlement Disadvantages

  • Sensitive interest rates
  • The perception of lower investment returns
  • Documentation requirements

Structured Settlement Advantages

  • Payments are tax-free
  • There are no management fees
  • Zero investment worries
  • Security.
  • No risk of fund dissipation
  • Lifetime Payments
  • Indexed for inflation
  • Quicker resolution
  • Greater payments in the long-term

Structured Settlements (Continued)

The most significant difference between lump sum payments and Structured Settlement payments comes in the area of taxation. Lump sum settlements are tax-free upon recieving one. However, after the age of twenty-one, any income arising from the investment is added on top of any other income, which causes it to become taxable income.

On the flip side, all payments coming from a Structured Settlement are 100% tax-free. Another difference addresses the area of inflation. Over the course of time, the dollar becomes weaker and weaker. A lump sum payment does not account for inflation and the weakening of the dollar. As time passes, more and more of the settlement capital must be used to maintain purchasing power. Structured Settlements take into account inflation from the start. With Structured Settlements, payments recieved can be indexed to ensure that the income of the claiment gradually increases as time passes. The index rate is determined before the settlement is finalised, and takes into account future price increases, and future cost-of-care increases.

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