Structured Settlement Investments: Example, Benefits, and Risks
Estimated reading time: 6 minutes
Patience often pays off in investing, and structured settlement investing is a prime example of how playing the long game can lead to big rewards.
Structured settlements arise when individuals receive a series of payments, typically as the result of personal injury lawsuits, workers’ compensation claims, or other legal settlements. However, some recipients prefer immediate cash and choose to sell their future payments to investors.
As an investor, you purchase the rights to these future payment streams at a discounted rate. This provides you with a steady return over time, as payments are made according to the original settlement schedule. Since these payments are often backed by highly-rated insurance companies, structured settlement investments are considered relatively low-risk.
In this article, we’ll break down how structured settlement investing works, including an example, benefits, risks, and how you can combine this asset class with the potential for tax-advantaged growth.
Table of Contents
- What are Structured Settlements?
- Investing in Structured Settlements
- Example of Structured Settlement Investing
- Potential Benefits
- Risks to Consider
- Investing with Your IRA
- How to Set Up an SDIRA and Invest in Structured Settlements
What Are Structured Settlements?
A structured settlement is a financial arrangement that originates from a legal settlement, typically arising from cases like personal injury, workers' compensation, or wrongful death claims. Instead of receiving a lump sum payment, the recipient agrees to receive periodic payments over a set period, which can range from several years to a lifetime.
These payments are often set up to provide long-term financial security, helping the recipient cover medical costs, living expenses, or other long-term financial needs. The insurance company is responsible for making these payments, and they are generally considered to be low-risk because they are backed by the insurance company's financial strength.
Investing in Structured Settlements
Investing in structured settlements typically involves purchasing the rights to receive the future payments from someone who holds a structured settlement. These recipients, often in need of immediate cash, sell their future payment streams at a discount to investors, providing an opportunity for investors to earn a return on their capital.
Here’s how someone can invest in structured settlements:
- Find a Reputable Broker or Marketplace: Investors generally work with brokers or firms that specialize in buying and selling structured settlement payment rights. These intermediaries connect buyers with sellers and facilitate the legal processes.
- Review the Terms of the Settlement: Investors need to thoroughly understand the payment schedule, including the timing and amount of payments, as well as the discount at which the payments are being purchased.
- Assess Risk and Legal Compliance: Structured settlement investments are generally considered low-risk because they are backed by insurance companies. However, it’s essential to ensure the transaction complies with state and federal regulations, and conduct further due diligence on the settlement itself.
- Purchase the Payment Rights: Once terms are agreed upon, the investor purchases the right to receive the payments. The insurance company continues to make payments on the original schedule, but now they go to the investor instead of the original recipient.
- Receive the Payments: After the transaction is completed, the investor begins receiving the periodic payments as outlined in the structured settlement agreement.
Example of Structured Settlement Investment
Suppose you have the opportunity to purchase a structured settlement that will pay $50,000 annually for the next 15 years. The total value of the settlement is $750,000. The original settlement holder, needing immediate liquidity, offers to sell the future payments for a lump sum of $550,000.
- Total settlement value: $750,000 (15 payments of $50,000 annually)
- Purchase price: $550,000
- Annual return: $50,000
Since you’re purchasing the settlement at a discount, you receive $50,000 annually for 15 years, totaling $750,000 in future payments. With an initial investment of $550,000, your total return is $200,000.
To calculate the effective rate of return:
- Annual payments: $50,000
- Purchase price: $550,000
- Time: 15 years
Your internal rate of return (IRR) for this investment is approximately 7.4% per year. This is a higher return compared to many traditional fixed-income investments, such as bonds or CDs, which makes it particularly attractive to long-term investors seeking stable and predictable income streams.
Benefits of Structured Settlements Investments
Investing in structured settlements offers several potential advantages, especially for those seeking stable, predictable income with lower risk. Below are three of the top potential benefits of this asset class:
Steady, Predictable Income
Structured settlements provide regular, fixed payments over time, making them an attractive option for investors looking for consistent income. These payments are typically guaranteed by insurance companies, reducing the risk of default.
Relatively Low Risk
Since structured settlements are often backed by highly-rated insurance companies, they are generally considered a low-risk investment compared to stocks or other volatile assets.
Diversification
Structured settlements may serve as a solid diversification tool within an investment portfolio. Since they are not correlated with stock market performance, they could provide a buffer against market volatility, contributing to a more stable overall portfolio.
Risks of Structured Settlement Investments
While structured settlement investments can offer stable and predictable income, they also come with some potential drawbacks. Below are three of the most significant risks investors should be aware of:
Liquidity Risk
Structured settlements are generally illiquid, meaning that once you invest, it’s difficult to convert them into cash quickly if you need the funds. You are locked into the payment schedule set by the settlement, which might not align with your future financial needs.
Default Risk
Although structured settlements are usually backed by insurance companies, there is still a risk of default if the insurer becomes insolvent or is unable to meet their payment obligations. While most insurance companies are financially stable, economic downturns or mismanagement can lead to defaults.
Devaluation Due to Inflation
Structured settlements usually pay a fixed amount over time, which means the real value of your income may decrease due to inflation. If the settlement does not include any adjustments for inflation, the value of the payments will likely decrease gradually over the years.
Investing in Structured Settlements with Your IRA
Interested in investing in structured settlements but lack the requisite funds? There may be another pool of funds hiding in plain sight — your retirement funds.
However, most IRA providers only allow investments in publicly traded securities like stocks, bonds, and mutual funds. What if you want to pair the stability and growth potential of structured settlement investments with tax-deferred or tax-free growth?
You might want a self-directed IRA (SDIRA).
A self-directed IRA works similarly to any other IRA you’d open with a bank or brokerage, operating under the same rules and offering the same tax benefits. The key difference is that an SDIRA allows you to invest in any asset the IRS allows, including real estate, private equity, structured settlements, and more.
How to Set Up an SDIRA and Invest in Structured Settlements
Here’s a step-by-step guide to start investing in structured settlements with your retirement funds:
- Choose a Reliable SDIRA Provider: Find a reputable SDIRA provider like The Entrust Group that allows investments in structured settlements. Look for a provider with experience, transparent fees, and strong customer service.
- Open and Fund Your SDIRA: Complete the application process. At The Entrust Group, opening an account takes as little as 10 minutes. Fund your SDIRA by transferring funds from an existing IRA, rolling over funds from a previous employer’s 401(k), or making a direct contribution.
- Research Structured Settlements: Look for structured settlement opportunities that align with your retirement goals and risk tolerance. Consider working with brokers to identify settlement payments that are available for purchase. Be sure to conduct thorough due diligence on the insurance company backing the settlement to ensure the payment stream is secure and reliable.
- Direct the Investment: Once you’ve selected a structured settlement investment, submit a Buy Direction Letter provided by your custodian, instructing them to purchase the settlement on behalf of your SDIRA. The custodian will execute the transaction and hold the settlement in your SDIRA.
- Manage Your Investment: Monitor your structured settlement investment regularly to ensure payments are received as expected. Any income generated should flow directly into your SDIRA, maintaining the tax-advantaged status of the account. Keep an eye on market conditions and insurance company ratings to assess ongoing risk.
And that’s all there is to it.
Want to learn more about SDIRAs? Download our free SDIRA Basics Guide. Inside, we’ve included a more comprehensive breakdown of the IRS rules and examples of what you can and cannot invest in.
If you’d prefer to speak directly with an expert, schedule a free consultation with one of our SDIRA specialists. They’ll answer your questions and provide the guidance you need to make informed decisions for your portfolio.
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