Structured Settlement vs Lump Sum After an Injury

When a claim settles, the defendant's insurer can pay the whole amount as a lump sum or can use part of it to buy an annuity from a life insurance company, which then pays the injured person according to a schedule negotiated at settlement. The schedule can be anything the parties design: equal monthly payments for twenty years, payments for life with a minimum term, lump sums at ages eighteen, twenty-one and twenty-five for a child, larger payments timed to expected prosthetic replacements or college years, or payments that increase annually. The annuity company, not the defendant, makes the payments, and the injured person's recourse is against it.

Federal tax law treats the payments as part of the personal injury recovery, so they are not taxed, and neither is the growth inside the annuity that produces them. A $500,000 structure might pay out $800,000 over twenty-five years, all tax-free. A $500,000 lump sum invested after settlement earns taxable returns, and the comparison depends on the annuity rate, the investment alternative and the person's tax situation.

The structure is irrevocable. Once the release is signed and the annuity purchased, the schedule cannot be changed, the payments cannot be accelerated, and the annuity cannot be used as collateral. A person who needs money for a house, a business or an emergency cannot reach it, except by selling future payments to a factoring company at a steep discount through a court-supervised process, which is the source of most structured settlement regrets.

Structures are the norm for minors' settlements, because the court approving the settlement wants the money protected until adulthood and often beyond, and a schedule of payments at eighteen, twenty-one and twenty-five is the common form. They are the norm for catastrophic injuries, where lifetime care must be funded regardless of how any lump sum is managed, and where a life care plan's projections translate into a payment schedule. They are used for people who, by their own account or their family's, would not manage a large sum well, and for wrongful death settlements supporting a surviving spouse or children.

Lump sums suit smaller recoveries, where the amounts do not justify a structure's complexity; people with immediate needs, paying off a mortgage, replacing a lost business, funding education now; and people with the discipline and advice to invest for themselves. A lump sum's flexibility is its value, and its risk is that large sums are mismanaged, lost to relatives and schemes, and spent, at rates that settlement planners cite to argue for structures.

Most significant settlements are a combination: a lump sum sufficient for the attorney's fee, the liens, immediate expenses and a reserve, and a structure for the remainder. The proportions are the decision, made with a settlement planner, who models the alternatives, and sometimes a financial advisor and a tax professional. The defense does not care which the injured person chooses, since the cost to it is the same, though defense-side brokers earn commissions on structures and the injured person's own planner should be independent.

Suppose your claim for a serious leg injury settled for $900,000. The attorney's fee and costs were $320,000, the health insurer's lien was negotiated to $60,000, and you had $25,000 in immediate expenses, leaving $495,000. You were 41, could not return to your trade, and had a spouse and two school-age children.

A settlement planner modeled alternatives. One: take the $495,000 as a lump sum, invest it, and draw on it. Two: take $150,000 as a lump sum for a reserve and retraining, and structure $345,000 into monthly payments for twenty years plus lump sums at each child's college age, all tax-free, with the annuity's internal growth adding substantially to the total paid out. Three: structure for life with a fixed period.

You chose the second, for the tax-free growth, the steady income during retraining, and the protection against the risk you recognized in yourself. The schedule was written into the settlement agreement before the release was signed, and the annuity company's obligation was confirmed. Had you later needed the structured money for an emergency, you could not have reached it except by selling payments at a discount. All figures are hypothetical; the mixed structure with a planner's modeling is the usual approach.

The structure decision is part of the settlement, not a step after it, and it cannot be revisited.

• Retain an independent settlement planner, not the defense's broker, to model lump sum, structure and combinations against your needs.
• List your immediate needs, debts, housing, retraining and a reserve, and fund them from the lump sum portion.
• Consider who will manage a lump sum and how; be candid about the risk of mismanagement, pressure from relatives, and schemes that target settlement recipients.
• For lifetime care needs, align the structure's payments with the life care plan's projected expenses, including periodic large costs.
• Consider public benefits: a lump sum can end Medicaid or SSI eligibility, and a special needs trust, funded by lump sum or structure, preserves it.
• Confirm the annuity company's financial strength rating, since the payments depend on it for decades.
• Have the schedule written into the settlement agreement and confirmed before the release is signed; afterward it is fixed.

The tax treatment is federal: payments from a structured settlement of a personal physical injury claim are excluded from income, as a lump sum would be, and the growth inside the annuity is not taxed, under provisions of the tax code that apply nationally. Punitive damages and interest are taxable in either form, and the allocation of a settlement between taxable and non-taxable components is addressed in the agreement.

Minors' settlements are governed by state court procedures that commonly favor or require structures or restricted accounts, with the judge reviewing the schedule. Sales of structured settlement payments to factoring companies are regulated by state structured settlement protection acts in nearly every state, requiring court approval of each sale on a finding that it is in the seller's best interest, after the abuses of the industry's early years; the discounts remain steep.

Medicare's interest in future medical costs may require a set-aside arrangement in some settlements, which can be funded by a structure. Special needs trusts, to preserve Medicaid and SSI, are governed by federal and state rules and can receive structured payments. Workers' compensation settlements, where permitted, have their own state rules on lump sum versus periodic payment.

Companies advertise to buy future structured settlement payments for cash now, and the business exists because structures cannot otherwise be accessed. The price is a steep discount: a stream of payments worth $200,000 over fifteen years might be bought for a fraction, at effective interest rates far above any loan. Every state requires court approval of a sale, with a judge finding the sale in the seller's best interest and the seller advised of the terms, and courts refuse sales that are plainly improvident.

A person considering a sale is usually in financial distress, which is the circumstance the structure was meant to prevent and the circumstance in which the discount is worst. Alternatives, a loan, a hardship arrangement with creditors, a partial sale of a single payment rather than the stream, are considered first, and an attorney or planner independent of the buyer reviews any proposed sale.

The existence of the secondary market is the strongest argument for setting the lump sum portion of a settlement large enough that the structure is never the only source of funds.

The choice between a structured settlement and a lump sum is made once, before the release is signed, with an independent planner's modeling, against the person's needs, discipline, benefits and lifetime costs, and most significant settlements combine the two. The questions to answer early are what the immediate needs and liens are, whether public benefits must be preserved, whether lifetime care must be funded, and who will manage a lump sum. Most personal injury attorneys work on contingency and bring in a settlement planner at the settlement stage.

Ask Legal Matters is a free claim-review request service, not a law firm, and does not provide financial advice. Requests may be shared with independent attorneys and legal services partners who handle inquiries in your state, and an attorney must evaluate the facts before anyone can say what the claim is worth. If you have a serious injury claim and want to understand how a settlement would be paid, you can request a free claim review.

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