If you are ignoring structured settlements, you are making a fiduciary decision that could be costly to you and the claimant, and if you rely upon the defense to structure the settlement you are jeopardizing maximizing your client's money with potential implications to your professional liability.

A lawsuit has settled in Texas in excess of $4 million on behalf of the plaintiff against their former attorney and ad litem for not recommending a structured settlement as part of the overall settlement. The attorney who fails to discuss this option forever loses the claimant's opportunity to participate in one of the most significant tax breaks available. The tax savings when structuring either taxable or non-taxable periodic payments can result in a sizeable difference, particularly with the variable annuity that offers the potential for tax-free gains from stock and bond investment accounts.

Traditional Structured Settlement Annuities vs. Other Investments

Traditional structured settlement annuities can provide the highest after-tax return with the lowest risk in today's interest rate climate, with no money management fees.

We frequently hear from investment people about the rate of return on traditional structured settlement annuities vs. other investment products. It is important to keep in mind that these payments, by Federal Statute (section 104(a)(2) personal physical injury or sickness), are totally tax-free from any Federal, State, City, Social Security or Medicare taxation. In addition, they are contractually guaranteed by multi-billion dollar life insurance corporations.

The income generated by investment of a large settlement would typically result in higher tax brackets. Therefore, one would need to earn 30% to 40% greater rates each and every year throughout a lifetime to equal the same rate of return as the traditional structured settlement annuity on a net after-tax basis.

Today's investors often overestimate their knowledge, and their expectations are sometimes way out of line.(1) While market returns over short terms can paint a rosy picture, history has shown returns above the mean to be unsustainable.

When comparing rates of return of a traditional structured settlement annuity vs. another investment, it is important to compare those returns over a period of time comparable with the life expectancy of the individual claimant.

The average return of a balanced portfolio of 60% stocks, 40% bonds has averaged 8.7%. That 86 years is comparable to an average life expectancy. (2)

Traditional structured settlements compare very well to that benchmark when considering the taxable equivalent guaranteed yield, net of fees and taxes (there are no ongoing fees, commissions, reporting requirements or additional expenses in connection with the structured settlement annuity).

If the claimant has sustained serious injuries, "age rated" annuities often produce a higher tax equivalent internal rate of return guaranteed for a lifetime, with almost no risk.

A diversified portfolio includes conservative investments such as those offered through traditional structured settlement annuities, and the "tax-free" periodic payments produce higher returns than similar investments with taxable earnings. At a minimum, we suggest the claimant consider a portion of their portfolio that would normally be invested in conservative products such as U. S. Treasuries, Municipal Bonds, Corporate Bonds, etc. (typically one-third to one-half of the settlement) be placed in a "structure" as this can improve the rate of return on these moneys due to their tax-free status.

Many investment advisors do not understand traditional structured settlements and their advantages in a Bear market. Since a Bear market always follows a Bull market, the attorney must consider whether the claimant could stand to lose a large portion of their settlement. If the Dow drops 50% over a three year period as it did in the early 1970's, then eventually gains 50%, they do not break even...they have lost 25% (Example: $100/share; lose 50%=$50/share; gain 50%=$75/share). The impact of this downturn in the market compounds the loss when necessary withdrawals are made on monthly or annual basis. In essence, one has to liquidate twice the number of shares to equal the normal distribution, and cannot make up the loss.

An example of this is seen in the Ibbotson Associates graph, Potential Shortfall: The Risk of High Withdrawal Rates (3) where in 1972 withdrawals from a $500,000 portfolio consisting of 50% stocks (S&P 500), 50% bonds (5 year Treasury's) at an inflation-adjusted percentage (5%/$25,000 up to 9%/$45,000) of the initial portfolio began at year end. In each instance, the withdrawals depleted the portfolio to the extent that the loss of principal could not be recovered. This would not occur in a traditional structured settlement annuity.

The attorney must consider if the desire to obtain a higher rate of return supercedes the primary consideration to preserve funds for the use and benefit of the claimant.

Consideration should also be given to the many financial analysts that are predicting the stock market will turn into a bear in hibernation for years as Baby-boomers liquidate their holdings to fund their retirement, and inflation returns as the government builds huge deficits to fund Social Security and Medicare. (4)

Another factor to consider is that life expectancies are increasing at a rate close to one percent a year, making a person with a 20 year life expectancy at retirement actually live about 50% longer than the expectancy table reflects.(5) Could the claimant outlive their settlement...not if it is a lifetime payout in a structured settlement annuity.

If the injury is permanent, the settlement should be too!

NOTES

1. Patricia Abram, Sr. VP, American Skandia Life Assurance Corporation

2. Vanguard Portfolio Allocation Models, 1926-2012

3. Potential Shortfall: The Risk of High Withdrawal Rates, Ibbotson Associates

4. Boomernomics...William Sterling, PhD

5. The Other Side of Retirement Planning, Michael Stein, CFP