Finding Funds: All About Structured Settlements

Structured settlements are one way that courts and insurance companies make sure that not only is justice done, but that payments go toward their intended purpose. When you're involved in an accident, medical malpractice suit, or you're just retiring from work, a structured settlement provides for periodic, guaranteed, monthly or quarterly payments. But, sometimes, it's better to just take the cash. How do you choose the right payment option?

Understand What A Structured Settlement Really Is

A structured settlement is nothing more than an insurance annuity. An annuity is a contract that requires an insurance company to guarantee monthly, quarterly, or annual payments to an annuitant (the policyholder) for a set period of time.

Sometimes, the annuity specifies payments for a set number of years (i.e. 10 years). These types of annuities are called "period certain annuities." The other type of settlement option available is a life payment annuity. These annuities make payments for the life of the policyholder.

For example, let's say that you win a lawsuit. The defendant must pay you $1 million. A period certain annuity settlement option would require an insurance company to pay the $1 million out to you over a period of 10 years, with interest. The life payment option would require the insurer to pay that same $1 million out to you over your entire life.

Why choose the life option? Because payments continue regardless of how long you live - even if you would have otherwise spent all of the million dollars. So, it's possible that you could end up getting more than what you would receive under the 10 year payment option, if you live longer than you life expectancy calculated by the insurance company.

Why They Are Beneficial For You

Structured settlements have a huge benefit over lump sum payments: certainty. With a lump sum payment from a retirement plan, personal injury claim, or medical malpractice suit, you are on your own to manage the funds.

If you run out of money before all of your medical expenses are paid, or before you die, you're out of luck. With a settlement option that's structured, you will never run out of money before the contract expires. For lifetime payments, it's impossible to run out of money before you die.

Why You Might Want To Sell One

With structured settlements having a seemingly unbeatable advantage, why would you ever choose a lump sum payment? One reason: you have immediate expenses that require cash right now. But before you sell your structured settlement payment, keep in mind that any company willing to buy your payments won't give you the full value of your structured settlement.

Companies, called factoring companies, buy structured settlements for a discount. A discount factor of 8 to 14 percent is common. On the high end, at 14 percent, you will receive only a small portion of your total structured settlement option. For example, a $1 million settlement option can quickly turn into a lump sum of just $250,000 or less.

Why so little? Because of the time value of money - a $1 today is worth a lot more than $1 20 years from now. Even though it seems like a small amount of money to accept in lieu of the full settlement payment, it's not always a bad deal. As always, consult with an attorney or financial planner before you sign anything.

Melissa Rudd is a financial consultant with several years experience. When she's not in the office, she enjoys sharing her insights by blogging online.