This is an in depth guide of what is structured settlement. For understanding the basics refer to our structured settlement faq. A structured settlement is a legal process wherein a financial payment for compensation of a personal injury tort would be resolved through an installment instead of one whole payment. This article would serve to clarify the concept of what is a structured settlement, the reasons for these kinds of payout plans as well as its advantages and disadvantages.
Definition of a Structured Settlement
The United States is one of the most developed structured settlement jurisdictions on the world, where both the federal as well as state levels have passed laws as well as regulations in support of these kinds of compensation packages.
The first and most pervasive structured settlement statutes can be found under special tax rules n Public Law 97-473 or the Periodic Payment Settlement Tax Act of 1982. This law was specifically enacted to encourage the use of structured settlement programs to allow for financial security for seriously injured victims and their families. There are certain requirements required to fall under the definition of a structured settlement:
a) There must be a suit or a settlement agreement which contain provisions for payment of damages over a specific period of time. This would be excluded as gross income under the Internal Revenue Code Sec 104(a)(2);
b) There must be a compromise agreement which detail a compensation package paid over a period of time under a specific workers’ compensation law. This income is also excluded under the Internal Revenue Code Sec 104(a)(1);
c) The periodic payments must fall within the descriptions provided above and is payable to a person as described below:
i. The recipient is a party to the suit or agreement or claim for workers’ compensation;
ii. The person has assumed liability for the periodic payments under a qualified assignment in accordance with the US Internal Revenue Code Sec 130;
Requisites for a Structured Settlement
a) The claimant is an injured party that enters into a settlement agreement for the dismissal of the lawsuit against the defendant or its insurance carrier.
b) In exchange for such dismissal, the defendant or their insurer would enter into an agreement to undertake a number of payments over a period of time.
c) In order to have funds for the said payment structure, there are two approaches commonly done:
i. The insurer purchases an annuity from a life insurance company, an arrangement known as ‘buy and hold’ case;
ii. The insurer assigns or delegates its obligation to pay the injured party to a third party. The third party in turn purchases a ‘qualified funding asset’ in order to generate funds for the periodic payment plan. This may either be in the form of an annuity or an obligation of the US government.
iii. In the case where an insurer does not assign the case, the defendant and/or their insurer would retain the obligation to make payment and offset the payout through the purchase of an annuity from a life insurance company. The payments made under the annuity would be exact in timing and amounts as the agreed upon payouts in the settlement.
- The defendant and/or the insurance company would own the said annuity and would name the injured party as the recipient of the fund payouts;
- If the payments are dependent upon the continued life of the injured party, then the latter would be called the annuitant;
History of structured settlements
The passage of HR 2884 by the US Congress back in 2001 and was enacted as law effective July 1, 2002 as Internal Revenue Code Sec 5891. By signing this into law, the material tax issues attendant to structured settlements have been removed. The law puts in place a paradigm for the whole industry to operate.
In order to be exempt from excise tax penalties, there must be approval given by a state court under a state statute for its effectivity. There are specific requisites that require for baseline findings such as the best interest of the seller considering the welfare of the injured party’s dependents. As a result, many state legislative bodies have enacted state laws that regulate structured settlement transfers.
Why Get a Structured Settlement?
There are a number of advantages to undertaking a structured settlement instead of taking a one-time payout. The following are the payouts:
a) The whole transaction would receive favorable Federal Tax exempt status;
b) The whole yield on the fixed annuity would be favorable to the recipient;
c) The recipient would have a set and determined schedule of payments;
d) The recipient has the option to have either lifetime payments or a lump sum periodic payment;
e) The recipient would have financial security as well as financial freedom because of the payments;
In essence, the obligation becomes a long term investment for the party paying the settlement while the recipient would be assured receipt of amounts without need for demand or worry.
Disadvantages of Structured Settlements
On the other end of the spectrum, there are disadvantages of a structured settlement. These are as follows:
a) The time element of the money is a major factor. A lump sum would mean the individual would receive full value while a structured settlement would result in a decreasing value over time, owing to the effect of inflation and other devaluation forces on value of money;
b) The entry into a structured settlement agreement, once confirmed by law cannot be changed especially with regards to changing needs of the recipient. This would mean that in the long term, the value of the received funds would not be enough compensation;
c) The structured settlement agreement, which utilizes financial companies and instrumentalities, are subject to changes in the economic structure, such as recession, bank runs or insurance companies folding up. Should these occur, the recipient would have a harder time to receive funds due them.
Structured settlements are means to an end, which is compensation paid out for an injury sustained by a party. Proper review of all the factual circumstances of the case is necessary in order to have the proper compensation scheme, be it a structured settlement payment or a lump sum payment, is to be decided upon for the long term benefit of the injured party.
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