A while back, my colleague Tiya Lim and I wrote about the problems of investing in securitized structured settlement payments. These are future annuity payments that a structured settlement beneficiary sold for cash. For a variety of reasons, we urged investors to stay away.
After that post appeared, readers wanted to know if there were similar concerns about structured settlements that weren't securitized. The two products serve different purposes and shouldn't be confused. For someone who's been injured, a properly designed structured settlement (non-securitized) offers significant tax and financial advantages.
A structured settlement is often used to settle accident and wrongful death lawsuits. Under the federal tax code, you have the option to designate all or part of your financial settlement to fund a structured settlement annuity. This annuity will provide regular income-tax free payments tailored to your specific needs.
Need a wheelchair replacement every four years? You can have periodic lump sums. A daughter goes to college in 2019? You can fund four years of tuition through your payments.
A structured settlement offers advantages that you can't get anywhere else. Let's start with the tax benefits. All income from your annuity is exempt -- not deferred but completely exempt -- from federal and state taxes. Your payments are also exempt from taxes on interest, dividends, capital gains and the dreaded AMT. (For more information, see Sections 104 and 130 of the Internal Revenue Code.)
With taxes almost certain to rise in coming years, that's not a bad place to be. By contrast, if you take your settlement in cash, you need to account for the fact that additional interest or dividends may push you into a higher tax bracket.
Additionally, anyone who has been injured (especially seriously) will want to maintain eligibility for government means-tested programs. According to the National Structured Settlements Trade Association, with as little as $2,000 in assets, you can be disqualified from Supplemental Security Income, Medicaid and private care programs based on Medicaid eligibility.
Without that eligibility, medical and living expenses can quickly deplete even large settlements. Ultimately, that would leave you wholly dependent on government funding. Needless to say, that's a terrible prospect.
But you may be able to avoid that problem by establishing a trust to pay for injury-related care and then funding that trust through a structured settlement. If you fund the trust irrevocably with a structured settlement, the government doesn't consider you to "own" the future annuity payments and therefore you have a greater chance of maintaining your eligibility. (As with anything like this, check with a tax attorney before proceeding.)
But beyond the tax and eligibility issues, there's another, perhaps even bigger issue. How exactly do you manage a settlement so that it guarantees you the regular income you need to live?
This is crucial. As Christopher Coyne, a finance professor at St. Joseph's University and expert in post-accident financial planning explains, "Conventional investing logic doesn't apply for plaintiffs in injury or wrongful death accidents. Guaranteed income is vital and few have experience creating plans to meet this need."
Finally, there's an unsavory but important issue for anyone suddenly coming into a lot of money. If you're looking at the prospect of a sudden windfall, be prepared to have people ask you for money. Family members, friends, old flames and even churches. Your long-forgotten Uncle Harold will emerge from nowhere with the promise of a 40 percent return if you invest in his Florida real estate operation. Beware!
Ironically, a final benefit of a structured settlement is that you don't get all your money immediately. The annuity payments are spaced out to keep you -- and especially anyone else -- from wasting the money funding your future.
A lawsuit settlement may be your one-time chance to protect your finances for years or even decades. The IRS makes structured settlements very attractive. Consider taking the agency up on its offer.