If you have been granted a structured settlement as a payment for an award from an insurance company or lawsuit, you may be wondering, what is a structured settlement? Structured settlements are formal financial arrangements where the party that owes money pays the claimant in installment payments, instead of as a lump sum payment. If you win or settle a lawsuit, the courts may decide to set up a structured settlement which is a form of a guaranteed payment of your award amount over the course of your lifetime. The installment payments can be structured in several different ways to protect you from inflation and they are exempt from Federal taxes. These payment arrangements offer both advantages and disadvantages, so taking some time to learn how a structured settlement works can help you make some sound financial decisions in the future.

Structured Settlements: What Are They?

When you're wondering, what is a structured settlement?, you can take a look at the IRC definition or consult with a lawyer to determine how the payment arrangement will benefit you. Structured settlements are a guaranteed source of tax-free income and the payments are calculated based on your total award amount. The settlement amount is determined by a judge and the judgment serves as the settlement of a lawsuit. You may have sued a company for malpractice or won a personal injury lawsuit. Whatever the case may be, the monies owed to you will be paid out over a series of installment payments under the structured settlement agreement.

Many people are happy with this type of financial arrangement, but others may prefer to receive their payment as a lump sum at a later date. If they want to get a lump sum payment, they will need to sell their structured settlement to a third party. Any sales are governed by state laws and will only be valued as a percentage of the original award amount.

Pros and Cons of a Structured Settlement

Setting up a structured settlement agreement has both pros and cons, and some people are better off financially by sticking with an installment payment plan.

Some of the pros of a structured settlement are as follows:

  • Payments are tax free. Unlike lump sum payments which may be subject to state and Federal taxes, structured settlement payments are tax free.
  • Provide a sense of security. For many people, having a structured settlement payment come in periodically throughout the year provides some financial stability and security.
  • Save on court costs. When a structured settlement is agreed upon, it is usually done outside of the court. This reduces costs associated with court fees.
  • Flexible payment options. Structured settlements can be set up to be paid out over five years, twenty years or even over the course of a lifetime.

While structured settlements offer a number of benefits, they also have some drawbacks. Some of the cons of a structured settlement are as follows:

  • Cannot be modified after agreement. Once the structured settlement has been agreed upon, the terms cannot be changed.
  • No interest paid out on payments. The interest is already built into the payments and adjusted for inflation, so you won't be able to collect additional interest on the funds.
  • Cannot be used as collateral. The payments themselves cannot be used as collateral for a loan, but you can declare the payments as a source of income to get a better rate or when applying for a loan.