Considering Structured Settlements With Injury Suit Proceeds

Q: Our daughter who is now in college is soon to receive the proceeds from a lawsuit settlement. She was injured in an accident. I've heard of a structured settlement that we could receive instead of a lump sum which we would be responsible for managing. What do you see as the better option?

A: Typically, lawsuit settlements are paid out in a lump sum to the injured party so long as they are not a minor. While this gets everything settled and enables the recipient of the money to know what they're dealing with, managing a lump sum over time presents challenges. The biggest are knowing how to invest the money and how much of it to use over time to make it last as desired.

Structured settlements offer a potential solution to these difficulties. An awarded lump sum typically goes into an annuity held by a third party (typically a life insurance company) and there must be a clearly defined payment stream which can't be altered. So, for example, if the recipient would like a monthly income but then also a chunk of money in say five years for a home down payment or anticipated educational expenses, that all needs to be planned up front and can't later be changed. (Using Treasury bonds is another approved structured settlement investment vehicle although they generally return less than an annuity).

In addition to doling the money out over time so it is more likely not to be squandered, a break provided in the tax code (The Periodic Payment Settlement Act of 1982), is another reason to consider a structured settlement. All payouts in a structured settlement, including earned investment returns, are free of taxation.

Structured settlements, which can only be agreed to at the time of a settlement, may only be done in physical injury cases. According to a spokesperson for the National Structured Settlements Trade Association (www.nssta.com), "Structured Settlement Brokers" tend to be financial planners and former lawyers.

The alternative to a structured settlement is to take the lump sum and invest the money on your own. "There are lots of ways to turn a lump sum of money into an income stream...some are inexpensive, some are costly. There are plenty of conservative balanced mutual funds that don't require monitoring. Automatic withdrawal programs can create an income stream. This approach has a high probability of being successful because it is low cost and balanced. Investing doesn't have to be complicated," says Fran Kinniry, Principal, Vanguard Investment Strategy Group.

Kinniry adds, "You should remember that any form of insurance or guaranteed payment stream creates costs and this is structured in favor of the company creating product. Remember, insures are in business to make money."

Another thing to do is to assess you daughter's likelihood to be responsible with the money. The downside to a lump sum is that you daughter could quickly burn through the money for whatever purpose she likes. To be fair, a person can waste money received through structured settlement payments but they at least will receive portions of the money over time. You could also establish a trust to be part of a structured settlement and the trustee could then dispense the money for specified purposes (e.g. educational expenses, living expenses, medical expenses, etc.).

Because of the tax benefits, the further out payments with a structured settlement can compound and produce somewhat greater investment returns. However, the annuity fixed returns tend to be quite modest. According to broker Michael P. Kelly with Structured Financial Associates, the returns tend to be a little higher than the current yield on 30-year Treasury bonds. He cites a recent case of a 38 year old with normal life expectancy getting a 5.4 percent return on their structured settlement annuity.

John Darer, a structured settlement broker with 4Structures.com, also suggests that the broker should disclose his commission which Darer says typically runs around 4 percent on annuities.