by John Darer® CLU ChFC MSSC RSP CLTC
David Dedman of Lexington Wealth Management and author of The Diligent Investor (” Ded-Man Talking”), has this to say about ways to receive your legal settlement:
“How you will receive your legal settlement? Typically there are two types of legal settlements. A structured annuity and a cash payout. Many people are forced to take the cash payout to relive (sic, I think!) medical debt. A cash payout will be a smaller sum than the structured annuity, very much like the options if you win the lottery. Structured settlements allow you to be paid over years or even decades. With a lump sum payout, you’ll have to contend with legal fees, investing and taxes”.
Time for the structured settlement watchdog “smirk walk”:
1. There are actually more than two types of legal settlements
Dedman’s assertion is overly simplistic and untrue. It’s tantamount to asserting that there are two types of investments, stocks and bonds. Sometimes settlements simply involve an agreement to perform an action, or stop performing an action.
2. Legal fees must be paid whether you do a structured settlement or not.
Lawyers generally work on contingency fees for personal injury cases, medical malpractice, product liability wrongful death, auto and air crash cases. The lawyer’s contingency fee is either paid in cash as a percentage of the cost of the settlement (including the cost of the structured settlement annuity), after payback of expenses, or the lawyer or law firm may, with the consent (and for the convience) of their client, elect to structure their fee.
Example 1 You settle a case for 1,000,000 for cash in the middle of trial and the contingency fee agreement with your attorney is 33.33% (1/3). Your lawyer has $100,000 in expenses that must first be reimbursed off the top before the contingency fee percentage is applied. The legal fee is $300,000 [$1,000,000-$100,000=$900,000; $900,000/3=$300,000]
Example 2 You settle a case in the middle of trial, for cash and a structure that pays you monthly income for the rest of your life with a $75,000 lump sum payable around the time your daughter turns 25 to help fund her wedding bash (I know you’re welling up with the thought!). The structure costs $400,000. The contingency fee agreement with your attorney is 33.33% (1/3). Your lawyer has $100,000 in expenses. Your legal fee is $300,000 [$1,000,000-$100,000=$900,000; ($500,000/3)+($400,000/3)=$300,000]
Note with cases that do not involve physical injury or sickness, lawyers often do not work on contingency fees and are generally paid by the hour, plus expenses.
3. Dedman compares future value to cash
A cash payout will always seem smaller than the total expected payout from a structured settlement. But if one is taking $500,000 in cash or accepting a structured settlement that costs $500,000, the cost is the same.
A structured settlement relieves the burden of investment risk and volatility associated with placing settlement money in mutual funds or stocks and provides a stable, secure source of income replacement backed by legal reserve life insurance companies, many of whom have been in business since the 19th Century!
4. Taxes on settlements
A settlement in which the cash or structured settlement payout is for damages on account of physical injury or physical sickness, within the meaning of IRC 104(a)(1) or IRC 104(a)(2), those payments are excluded from income. In other words they are income tax free.
If you have any sort of income in excess of your statutory exemption you will have to contend with taxes. Whether or not you agree to a structured settlement on a physical injury case you still have to contend with taxes on your other income and you must still file a tax return.
If you accept a structured settlement to settle a lawsuit that does not involve physical injury or physical sickness [e.g. employment case, defamation, wrongful birth in some states], or is for an element of such cases that involves taxable damages, then a structure may provide tax deferral until such time as the structured settlement payments are received by
As a Sudden Money® Advisor with experience in assisting industry victims on over 1,000 settlements, I find Dedman’s analysis to be lacking in both accuracy and vision. There are innovative approaches currently being implemented successfully to resolve legal cases, which Dedman has overlooked in his assessment.