Patty, 32, has suffered a serious brain injury in a terrible automobile accident. A lawsuit is pending against the driver of the other vehicle, who smashed into the back of Patty’s car. The defendant’s insurance company has offered to settle the case for the policy limits of $2.5 million, but proposes to “structure” the settlement so that Patty will receive guaranteed monthly payments for the rest of her life. Alternatively, the insurance company offers to simply pay the entire amount to Patty and her lawyers outright. Which is Patty’s better choice?
A structured settlement commonly involves the purchase, by the defendant’s insurance carrier, of an annuity calculated to pay certain sums at regularly scheduled intervals in the future. Insurance carriers representing defendants in a personal injury case often favor structured settlements because they can settle the case for less money up front than the actual value of the case. Insurance companies, however, often are unwilling to disclose the amount that will be paid to purchase the annuity. This can make it difficult for the plaintiff’s lawyer to evaluate the merits of the settlement offer.
Structured settlements are intended to provide a secure and fixed stream of recurring payments to a claimant over a long period of time. They avoid dissipation of lump sums by injured parties who may otherwise be left with no or few means of support. Strong public policy in favor of deterring claimants from squandering their settlements or awards has led to favorable tax rules for structured settlements.
Structured settlement payments are not subject to income taxes as they are received. The proceeds, however, can be subject to federal estate tax if there is a guarantee that payments will continue after the death of the plaintiff. In such a case the value of future payments still due after the plaintiff’s death would have to be calculated—and the number would, of course, change with each payment received before the plaintiff’s death.
Structured settlement annuities can be combined with lump sum payments to meet the specific needs of the injured individual. For example, lump sum payments can be used to pay medical bills, rehabilitation costs and debts of the injured party. It is common for structured settlements for younger plaintiffs to provide lump-sum payments designed to cover college costs, buying a home and starting adult life or other typical young-adult costs. Lump-sum payments might even be scheduled to cover predicted medical expenses (transplants, major equipment purchases, etc.) related to the underlying injury.
Settlements can be structured without the purchase of an annuity. The plaintiff can settle the matter for a lump sum and future payments and assign a certain amount of the settlement proceeds to a structured settlement trust. The trustee invests the proceeds to maximize asset growth and income, and makes periodic payments to the injured party.
In some cases a structured settlement by itself may cause a serious problem for the plaintiff. For instance, if he or she is receiving Supplemental Security Income (SSI) or Medicaid, the regular monthly payments might result in loss of those important benefits. This can be particularly problematic if the settlement amount is insufficient to take care of the plaintiff—as it might well be if the defendant’s insurance coverage was inadequate, or the plaintiff was partially at fault for the injury.
Payments from a structured settlement can be made to a special needs trust to help protect benefits . A special needs trust enables the individual with disabilities to retain existing means-tested public benefits such as SSI and Medicaid or to financially qualify for such benefits while having funds available to supplement the individual’s needs that are not covered by government programs. The trust funds can be used for myriad purposes, such as additional support services at home, vacations, companions, vehicles and a residence. If a special needs trust is created, the amount in the trust paid back to Medicaid will be deductible for federal estate tax purposes as a claim against the estate.
A structured settlement may be advantageous to the plaintiff because of the availability of large sums of money to the trustee of a special needs trust. Structured settlement payments often provide a fixed stream of income, and therefore, they usually will not be subject to unfavorable economic conditions such as recessions or inflation.
One of the disadvantages of structured settlements, however, is the inability of the injured party to change the amount received or the schedule of payments. When circumstances change and the injured party needs a lump sum of money (to purchase a house, for example), the injured party cannot simply give the annuity back to the life insurance company for a lump sum.
Similarly, the injured party is unable to unilaterally change the recipient of the structured settlement. There often is a need to make such a change when it is subsequently determined that the payments should be deposited into a special needs trust so that the injured person can receive public benefits.
Where there is a special needs trust in place, the trustee should ordinarily be named as the recipient of the structured settlement payments. If the plaintiff is named as the recipient, the payments can disqualify the disabled person from receiving means-tested benefits such as SSI and Medicaid even though payments are subsequently directed to the trust.
There are several advantages to structured settlements in personal injury cases, and several disadvantages. It can be challenging in individual cases to determine whether to agree to structure the settlement, and it can often happen that the best estimates by professionals at the time of settlement turn out to have been wrong as circumstances develop after the fact. But we can offer Patty (remember Patty?) some help in weighing the advantages and disadvantages:
Patty’s structured settlement payments would be tax-free. So would the initial settlement amount if she received it as a lump sum, but the interest or investment income she (or her special needs trust) received after the settlement would be taxable. That might not be terribly important if Patty has significant medical expenses (so that her income taxes are already reduced by the itemized deduction) of she or her trust can invest in tax-free bonds. Generally speaking, the larger the settlement, the more significant the tax implications will become.
Once Patty decides to structure her settlement, she loses the ability to use those funds to purchase major items (a house, major surgical intervention or other anticipated or unanticipated expenses). Her structured settlement cannot be reduced to cash, though there is an active industry of companies who will purchase her annuity for a fraction of what it will pay out over time.
One piece of good news about structured settlements is that they provide built-in investment management. Although the payouts are fixed, and the money is “invested” only in an insurance-company annuity, that does mean that Patty will not have to pay anyone to manage her funds before the annuity is paid out. If the money is received in a lump sum into a special needs trust, guardianship or conservatorship, the trustee (or guardian or conservator) will charge a fee for administration. Plus there may be other costs associated with any court or accounting requirements.
If Patty takes her settlement as an annuity she has effectively made the decision to invest in “fixed-income” products. Given her age and the size of her settlement, most financial advisers would probably suggest that she have some of her proceeds invested in stock market equities. She can accomplish that result by structuring part but not all—or even most—of her settlement.
What is the right answer for Patty? It depends, of course. It depends on her medical condition and needs, availability of other resources (is she covered under a spouse’s medical insurance, or is she already receiving Medicaid benefits?), risk tolerance and a host of other factors. Her $2.5 million settlement seems like a lot of money, but after payment of attorney’s fees and the costs already incurred by Medicaid, Medicare or her employer-sponsored insurance company, Patty’s needs may be hard to satisfy with the remaining money.
Patty’s best course would be to consult someone who knows about structured settlements, special needs trusts and management of personal injury settlements. To the extent that she and her lawyers rely on the insurance salespersons offered by the defendant’s insurance company, they may be getting an incomplete picture.
About the Author
Shirley B. Whitenack, Esq.  is a partner in the Morristown, New Jersey law firm of Schenck, Price Smith & King, LLP . A substantial portion of her practice is devoted to trust and estate litigation, special needs planning and trust administration, and Medicaid appeals. She is a member of the Special Needs Alliance and is also actively involved in the National Academy of Elder Law Attorneys  on both the state and national levels. She currently serves as Chair of NAELA’s Advocacy/Litigation Special Interest Group, is an active member of NAELA’s Annuities Task Force, and sits on the organization’s Board of Directors.