Beyond Television Commercials: Structured Settlements Demystified
You’ve probably seen the commercials, “get cash now!” What does it all mean? Well, if you’re currently receiving payments from an annuity, lotto winnings, or a personal injury suit, these commercials are an attempt to get you to part with your structured settlement. Is it a good deal? It depends.
What’s A Structured Settlement?
A structured settlement is an annuity that is managed by an insurance company. Regular monthly or quarterly payments are made based on a life expectancy formula for lifetime payments. For “period certain” payments, the settlement is paid out over a specific number of years. For example, a 10-year period certain pays for 10 years.
Some structured settlements, like retirement income annuities, offer provisions for death benefit payments. This is especially true for pension-type annuities where the structured settlement is intended to provide income for both you and your spouse forever.
What Are The Benefits?
Structured settlements come with many benefits. First of all, the interest rate on the payments are known in advance, as are the payments. If a lifetime payment option is selected, the primary benefit is certainty.
Structured settlements take luck out of the equation when it comes to budgeting for retirement income or lifetime payments on a personal injury settlement. With a lump sum of cash, you have to try to guess how long you’ll live – an impossible feat. You’ll also have to guess what interest rate you’ll receive and what future inflation will look like.
Rather than do that, most people transfer all of the risk to the insurance company. In exchange, the insurer guarantees payment according to the terms of the settlement option.
Why Sell A Structured Settlement?
As appealing as regular monthly payments are, you might need cash right now. What good does a million dollars do you over your lifetime, if you need a lot of money immediately to pay hospital bills or make extensive home renovations due to a disability? There are a few things to keep in mind as you research how to sell a structured settlement. First, not all liquidation companies are the same.
When you sell a structured settlement, the liquidation company will attempt to figure out the present value of all future annuity payments. This is done using a somewhat complex mathematical equation. At the end of it, you will receive a small fraction of your total settlement.
For example, a $1 million settlement spread out over your lifetime might only be worth $250,000 today. Why so little? Well, it has to do with the time value of money. Inflation erodes the value of a dollar, so $1 today is more valuable than $1 in the future. There’s also the matter of interest.
Annuity payments accrue interest over time – this interest hasn’t been earned yet and the liquidation company takes the risk of assuming the payments for the rest of your life. While few insurers actually go bankrupt, it’s still a risk the liquidation company factors in.
Ultimately, the best reason to sell a structured settlement for cash now is because you desperately need the money. Keep in mind that you don’t have to sell all of your annuity now. You can sell part of it, and then take a reduction in payments for a set number of years or for life.
When you sell a structured settlement, the biggest risk is that you lose the certainty that comes with guaranteed payments. Once you sell the annuity to a liquidation company, you can never get that money back.
Melissa Rudd is a legal and financial advisor of several years. In her free time, she likes to help others by posting on a variety of blog sites.