Interest rates continue to be at historically low levels. Even with recent hikes by the Federal Reserve, other factors playing into the equation are holding down rates. While that’s great for those buying property, it raises questions for injured workers setting up or dependent on a pre-established income stream — such as a structured settlement. The good news is, it really doesn’t matter.
Structured settlements are not investments like other products and, therefore, are not subject to the whims of Wall Street. They are guaranteed due to their underlying financial instrument – typically an annuity from a life insurance company. The structured annuity is guaranteed regardless of what happens in the market. As long as a highly rated insurance company is involved, there are strict regulations to ensure sufficient reserves are set aside for every annuity the company issues.
A deeper understanding of structured settlements sheds more light on how they work and why the interest rate environment is really not a factor.
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What is a Structured Settlement
First created in Canada, structured settlements came into this country in the 1970s exclusively for injured workers. Initially they were used on large, catastrophic injury cases; although now as many as half of structured settlements are often less than $50,000. Federal and state governments have passed myriad laws and changes to the tax codes over the years to make structured settlements more attractive.
Instead of taking the money received from a workers’ compensation settlement or personal injury lawsuit in one lump sum, some or all the money is put into a structured settlement for future needs and goals. A set amount of the money is distributed at preset intervals — monthly, quarterly, annually or whatever is agreed upon by all parties. It can be doled out over a finite period of time or for the person’s entire lifetime. The settlement may even include a portion for beneficiaries upon the injured worker’s death.
A typical structured settlement includes upfront cash for immediate needs, such as attorney fees or medical expenses. The remainder is then put into one or more annuities issued by a life insurance company, which makes the periodic payments to the injured worker.
Structured settlements include many inherent features that make them more appealing than lump sum settlements. Research continually shows that a majority of people who receive a single sum of money end up spending most or all of it too soon.
Among the additional benefits of structured settlements are:
- Guarantees. The payments to the injured worker from interest-earning annuities are backed by insurance companies, which are highly regulated.
- Tax Free. The injured worker receives a 100 percent lifetime exclusion from income, dividend and capital gains taxes.
- No Fees. Structured settlements do not include management fees.
- No risk. Because of their structures and guarantees, the injured worker receives the money as scheduled — regardless of current interest rates. Also, they are not managed as other investment products are, so are not in danger of ending due to poor investment results.
- Eligibility. Benefits from federal and private health care plans are protected.
- Customization. Working with an experienced, reputable company with appropriate knowledge and financial tools means the settlement can be designed to fit the specific needs and desires of the injured worker involved.
- Higher returns. One of the biggest advantages of structured settlements stems from their status as tax free. That translates to returns that are higher than those seen in low- to moderate-risk investments. To match or get a better return than what an underlying annuity provides would require taking on higher risk and more uncertainty.
For example, in order for an injured party to earn the 6 percent return rate of the structured settlement, he would have to earn an additional 3.23 percent on the cash investment at the 35 percent tax bracket (9.23 percent less 6.0 percent), an additional 2.33 percent at the 28 percent bracket and 2.0 percent more in the 25 percent income tax bracket. In addition to the added interest, the self-investor would have to subtract any local and state taxes, as well as the related brokerage or investment fees.
Getting long term workers’ compensation claims off the books and ensuring the injured worker’s needs are taken care of can be done relatively easily through a structured settlement. Those with the appropriate expertise in developing them create a win-win for all parties involved in the settlement.
Author Michael Stack, CEO Amaxx LLC. He is an expert in workers compensation cost containment systems and helps employers reduce their work comp costs by 20% to 50%. He works as a consultant to large and mid-market clients, is co-author of Your Ultimate Guide To Mastering Workers Comp Costs, a comprehensive step-by-step manual of cost containment strategies based on hands-on field experience, and is founder & lead trainer of Amaxx Workers’ Comp Training Center.
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Do not use this information without independent verification. All state laws vary. You should consult with your insurance broker, attorney, or qualified professional.