What are the Benefits of a Structured Settlement over a Lump-Sum Settlement?

What are the Benefits of a Structured Settlement over a Lump-Sum Settlement?

Introduction

When deciding how to receive compensation in a legal settlement, you may have two options: a structured settlement or a lump-sum settlement. Understanding the benefits and drawbacks of each type of settlement can be crucial to making an informed decision that aligns with your financial goals and personal circumstances. In this blog post, we will delve into the benefits of structured settlements and how they may be more advantageous than lump-sum settlements in certain situations.

What is a Structured Settlement?

A structured settlement is an agreement where the plaintiff (the person awarded the compensation) receives their settlement money in a series of periodic payments over time rather than as a single lump sum. The payments can be scheduled monthly, quarterly, or annually and customized to fit the recipient's needs.

Benefits of Structured Settlements over Lump-Sum Settlements

1. Financial Security and Stability

One of the most significant benefits of structured settlements is their financial security and stability. The periodic payments help to ensure a steady income stream for the recipient, which can be particularly beneficial for those with limited financial resources or who cannot work due to injury or disability.

This income stream can be especially valuable for individuals who may struggle to responsibly manage a large sum of money. Poor financial decisions can quickly deplete lump-sum payments, leaving recipients without the necessary funds to cover future expenses. Structured settlements can help prevent this by providing a long-term, predictable income source.

2. Tax Benefits

Structured settlements offer significant tax advantages compared to lump-sum settlements. The Internal Revenue Code states that the full amount of a structured settlement is tax-free if it results from a personal injury, wrongful death, or workers' compensation claim. This means that the recipient will not have to pay any taxes on their payments.

On the other hand, lump-sum settlements are generally taxable, which could significantly reduce the overall amount of money received. A large lump-sum payment could also push the recipient into a higher tax bracket, resulting in even more taxes owed.

3. Customization and Flexibility

Structured settlements can be tailored to meet the specific needs and goals of the recipient. The payment schedule can be customized for immediate financial needs, such as paying off medical bills. It can also be adjusted for future expenses, such as college tuition or retirement funds.

For example, a recipient might opt for larger initial payments to help cover immediate expenses, followed by smaller payments over the long term for ongoing financial support. Alternatively, they may have the payments increase over time to account for inflation or other anticipated increases in living expenses.

4. Protection from Creditors

Structured settlements can provide protection from creditors, as the periodic payments are generally exempt from garnishment, attachment, or seizure by creditors. This means the recipient's compensation will be secure, even in bankruptcy or other financial difficulties.

In contrast, lump-sum settlements can be more vulnerable to creditor claims. Once the settlement money is in the recipient's bank account, it can be subject to garnishment or attachment by creditors, leaving the recipient with little or no funds to cover their expenses.

5. Guaranteed Returns

When a structured settlement is established, the settlement funds are typically used to purchase an annuity from a highly-rated life insurance company. These annuities typically guarantee a specific rate of return on the invested funds, ensuring that the recipient will receive their scheduled payments as agreed upon.

In comparison, lump-sum settlements carry a higher risk for the recipient, as they are responsible for investing the money themselves. The recipient may not have the financial knowledge or experience to manage a large sum of money effectively, which could lead to poor investment choices and potential financial losses. The guaranteed return provided by a structured settlement annuity can provide peace of mind and financial stability for the recipient.

6. Protection from Dissipation Risk

One of the primary concerns with receiving a large lump-sum settlement is the risk of dissipation or the rapid depletion of the funds. Recipients may be tempted to make large purchases, invest in risky ventures, or lend money to friends and family. This can quickly erode the settlement money and leave them without the necessary funds to cover their future expenses.

Structured settlements help mitigate this risk by providing a steady, predictable income stream that is less likely to be squandered. The recipient is less likely to make impulsive financial decisions when the funds are distributed over time rather than as a single large sum.

7. Minimizing Family Conflict

In some cases, receiving a large sum of money can lead to family conflict or tension, as relatives may have differing opinions on how the funds should be used or distributed. This can be particularly problematic in cases where the settlement is intended to provide for the long-term care and support of the recipient.

Structured settlements can help minimize these conflicts by providing a clear, predetermined payment schedule that outlines how the funds will be distributed. This can help to reduce disagreements and ensure that the recipient's needs are met consistently and reliably.

8. Preserving Government Benefits

For individuals who receive government benefits, such as Medicaid or Supplemental Security Income (SSI), a lump-sum settlement could jeopardize their eligibility for these programs. These benefits are typically means-tested, which means that a sudden influx of cash could disqualify the recipient from receiving assistance.

In some cases, structured settlements can be designed to preserve eligibility for government benefits by carefully scheduling payments to avoid surpassing the resource and income limits imposed by these programs. Sometimes, a special needs trust can also be established with a structured settlement to further protect the recipient's benefits.

Conclusion

While both structured and lump-sum settlements have advantages, several compelling reasons exist to consider a structured settlement in certain situations. Financial security and stability, tax benefits, customization and flexibility, protection from creditors, guaranteed returns, protection from dissipation risk, minimizing family conflict, and preserving government benefits are all key benefits that make structured settlements an attractive option for many recipients.

Ultimately, whether to choose a structured settlement or a lump-sum settlement will depend on the specific needs and circumstances of the individual involved. It is essential to consult with a financial advisor, attorney, or other qualified professional to determine the best course of action for your unique situation.