If you are involved in a court case that involves a settlement for a large sum of money, the defendant or person proposing the settlement may set up an installment payment plan instead of a lump sum payment. This type of arrangement is known as a structured settlement and can be set up on any type of payment schedule that both parties agree upon. One of the key reasons why people set up a structured settlement is for tax benefits. When this type of payment arrangement is set up in a certain way, tax obligations may be reduced or eliminated completely. In some states, it is also possible to sell the structured settlement to a third party for a lump sum buyout.
How Structured Settlements Work
A structured settlement is actually a formal contract where an insurance company will set up an installment plan for giving out their award amount. The payment plan is tailored for the individual or payee by the payer, and all of the terms are negotiated until both parties are in agreement. This agreement is a contractual agreement and ensures that the defendant or insurer will pay the negotiated amount to the plaintiff or claimant.
If the settlement was paid as a lump sum payment, the amount would be subject to state and Federal taxes. When the payments are broken up with a structured settlement, the payments are free of tax liability.
Benefits of a Structured Settlement
In addition to the tax benefits, there are a number of other benefits of a structured settlement. For many people, there is an added security in getting smaller amounts of cash at regular intervals throughout the year. Some people simply aren't good with their money and can end up spending their entire settlement amount very quickly. For many, structured settlements work as a steady stream of income that will be available for several months and years to come.
Minors who are receiving a structured settlement can also benefit from this type of arrangement. The installments can be used to pay for college or educational expenses, or be put away in a savings account for their future. Those who are disabled can benefit from having funds from a structured settlement go directly into a trust fund.
Disadvantages of Structured Settlements
While a structured settlement offers several benefits, there are some disadvantages of this type of payment arrangement. Once the payment terms of this type of arrangement have been agreed upon, they cannot be changed. Another drawback is that the interest is already built into the payment, so you cannot earn interest on the funds. However, these payments are tax free so there is another monetary reward. Structured settlement funds cannot be used as collateral for a loan, but you can declare this as income for your loan and use it to apply for a loan if you need to.
Structured settlements do offer a number of benefits and may be the best resolution when it comes to setting up payment arrangements with an insurance company. However, there are some drawbacks to keep in mind when entering into this type of payment arrangement.