“Structured Settlements”: How They Work, Benefits, and Tradeoffs
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What a structured settlement is
A structured settlement resolves a claim by providing some or all of the recovery in scheduled payments over time instead of paying the entire amount at once. The parties agree on the payment schedule as part of the settlement. It may provide periodic payments for a set number of years, deferred payments beginning on a future date, or payments tied to a person’s lifetime, sometimes with a guaranteed period or other scheduled amounts. The precise schedule is negotiated; it is not a standard package.
How the payment arrangement is funded
In a common arrangement, the defendant or insurer makes a qualified assignment of its periodic-payment obligation to a separate assignee. The assignee purchases an annuity contract or other qualified funding asset that is designed to fund the promised payments. The claimant receives the payments under the settlement terms rather than receiving and investing the full settlement principal. The settlement documents should specify the amount, dates, duration, any guaranteed payments, any payments to beneficiaries after death, and what happens if the claimant dies before all scheduled payments are made.
Potential advantages
A structured settlement can create a predictable income stream, help reserve money for future care or living expenses, and reduce the risk that a large lump sum will be spent too quickly. The schedule can be designed around anticipated needs, such as education, housing, or future medical costs. For qualifying damages on account of physical injury or sickness, federal tax law generally excludes compensatory damages from gross income whether paid as a lump sum or periodic payments. A structure may also preserve the intended tax treatment while avoiding current investment-management decisions for the annuitized portion.
Potential disadvantages and risks
The main tradeoff is limited access. Once the settlement is finalized, the claimant generally cannot change the schedule or withdraw the full present value to meet an unexpected need. Inflation can reduce the buying power of fixed payments, and a schedule that seemed appropriate at settlement may not match later circumstances. The claimant also relies on the financial strength of the party responsible for payments and the annuity issuer, subject to applicable guarantees and their limits. Compare the payment schedule and the total nominal payments with the present value and the flexibility of a lump sum; a larger total over many years does not necessarily mean a better economic result.
Selling future payment rights for immediate cash is not a simple withdrawal. The buyer generally discounts the future payments, so the amount received may be substantially lower than their scheduled total. Federal law imposes an excise tax on certain factoring transactions unless a qualified court order or other statutory exception applies. Maryland’s Structured Settlement Protection Act requires court authorization for covered transfers and safeguards that include independent professional advice. A transfer should be reviewed for the payee’s needs and dependents, the discount rate and fees, taxes, and any public-benefit effects.
Taxes and public benefits
A structured settlement does not make every kind of recovery tax-free. Under Internal Revenue Code § 104(a)(2), the exclusion generally applies to compensatory damages received on account of personal physical injuries or physical sickness; punitive damages and interest are generally treated differently. Emotional-distress damages not attributable to physical injury are also subject to different rules. The allocation and tax character of the settlement matter, so the tax consequences should be assessed before signing.
Periodic payments can affect needs-based benefits such as SSI, even when the settlement principal is not paid as a lump sum. A claimant who receives SSI or Medicaid should coordinate settlement design with benefits counsel before the schedule is fixed; a first-party special-needs or pooled trust may be relevant, but the trust and payment terms must meet applicable rules. SSDI is not subject to an asset test, though other benefit programs may be.
Questions to resolve before agreeing
Before accepting a structure, compare a lump-sum option and one or more payment schedules; identify future medical, care, housing, education, and family needs; check inflation protection and beneficiary provisions; review the insurer and annuity issuer; and confirm taxes, liens, attorney fees, court-approval requirements, and public-benefit eligibility. The settlement is usually difficult to revise after it is final. A qualified financial professional and tax adviser can help model the options alongside the lawyer handling the claim.
Related Maryland Cases and Authorities
26 U.S.C. §§ 104(a)(2), 130, 5891; Md. Code, Cts. & Jud. Proc. §§ 5-1101–5-1104; Access Funding, LLC v. Linton, 482 Md. 602, 290 A.3d 112 (2022).