A structured settlement is when a person receives payments of cash at specific intervals, such as annuity lottery winnings, litigation settlement, life insurance, government entitlements, medical payments, and workers’ compensation.
Because personal circumstances can change, a recipient can choose to sell one’s structured settlement to factoring companies or brokers, which enables the individual to get some or all of the money upfront.
What To Avoid
When selling a structured settlement, there are three things to avoid:
1. Not seeking legal advice
There are federal and state statutes that prohibit the sale of certain types of structured settlements. Thus, you may want to consult legal counsel especially when large sums are involved.
“The federal law designed to provide these benefits to you on an income tax-free basis also prohibits you from assigning or encumbering them,” according to the National Structured Settlements Trade Association (NSSTA). “Federal law that assures the payments you receive are on a tax-free basis also prohibits converting your payments into a lump sum.”
In addition to Uncle Sam’s provisions, 47 states have structured settlement protection statutes that establish strict conditions for structured settlement factoring transactions. When it comes to certain types of proposed transactions, such as compensation for injury victims, court oversight and approval is required if recipients want to sell payments to a third-party company.
2. Ignoring the tax code
Special tax rules apply for certain structured settlements, such as those that are exempted from income taxes. These types of payments are typically prohibited from being converted into a lump sum payment. Here’s a guide by the Internal Revenue Service (IRS) on factoring structured settlements and tax implications.
Other types of arrangements are perfectly acceptable, such as converting annuitized lottery winnings or workers’ compensation into a lump sum payment.
Selling off structured settlements can make sense in certain situations. For example, you may want to pay off high interest credit card debt, or pay an expensive medical bill. Another common situation is when a student wants to convert periodic payments to pay for college, graduate school, or a jobs training program.
3. Going overboard
Recipients don’t need to sell a structured settlement in its entirety. Remember, it’s advisable to do such transactions based on your needs. You can partially monetize interval payments upfront.
A partial settlement is a good option if you don’t need the entire sum of your settlement in one payment. For some people, such as senior citizens, it may make sense to only monetize a portion so they still have some periodic payments left after the initial lump sum is exhausted.
Use a present value calculator to help you assess any proposed structured settlement transaction. Figure out how much money you need now, the discount rate, and how a proposed transaction could affect (reduce) residual payments.
When you get an offer, be sure to read the terms carefully. Here are a few considerations.
- Will you be paying market rates for factoring your periodic payments?
- Is the factoring broker or company offering a reasonable amount of cash upfront?
- If you are entitled to interest on your periodic payments, is the interest amount reflected in the lump sum offer?
- Are there any (hidden) charges or fees?
- What are the tax implications of the proposed transaction? Will you be complying with federal and state laws?