This guest post is courtesy of Anthony Lara, a recent business marketing grad from the east coast. He writes for several finance blogs.
If you are anticipating a damage award for a personal injury, you may be presented with two options: receive a lump sum payment (all the money in one fell swoop) or a structured settlement (regular payments over a set period of time). Here’s some guidance to help you figure out which way to go:
Who Decides How to Structure a Settlement?
According to the National Structured Settlement Trade Association (NSSTA), the injured party and the defendant typically decide jointly whether a damage award will be a lump sum or a series of payments for a set time period. If the injury victim is a minor, judges often rule that a damage award take the form of a structured annuity. This ensures that the young victim will have the money to pay future medical bills and compensate for loss of income.
Benefits of Structured Settlements
Congress approved legislation in 1982 supporting a tax exemption for individuals receiving structured injury settlements. Lawmakers believe that an annuity serves you better than a lump sum, because it holds funds in reserve for future use. Structured settlements also minimize your reliance on government funding for unpaid medical expenses. However, to take advantage of the special structured settlement tax exemption, you must let the issuer manage your money. Find out further details about this exemption by reviewing Publication 4345 at IRS.gov.
What If I Need the Cash Later?
Although a predictable cash payment constitutes a steady source of nontaxable income, you may find that at some point you really need the cash in hand. You may come across an investment opportunity you can’t afford to pass up or your growing family may need a larger house. According to Annuity.org, you can sell your structured settlement payments to a third party for a lump sum whenever you wish. You can trade all or part of your settlement for cash.
Your proceeds from the transaction are not taxable, but you should note that you will not receive the full value of your annuity or settlement when you sell.
Lump Sum Payments
Over time, your annuity payments could go down in value due to inflation. If you opt to get your entire damage award in one lump sum, you could invest part of the money as an inflation hedge. Financial websites like Forbes.com offer seasoned advice on the best investment products to preserve and expand the value of your settlement.
Also, by collecting the entire amount upon the completion of your settlement, you have enough to pay for your current medical expenses and compensate for time away from work. However, you will also be surrendering some of your settlement to the IRS, as lump sum payouts are taxable.