Successful plaintiffs in lawsuits are frequently awarded settlements paid out in periodic installments. A structured settlement recipient my keep the settlement or sell (factor) it at a discount and reinvest the proceeds. You're faced with a similar challenge as a third-party investor choosing between investing in a structured settlement cash flow and other annuity-type investments.
In former years, settlement sellers were pretty much in the dark as to worth, or the true present value, of their settlement cash flow stream.
Factoring companies, by state and federal law -- as of the date of publication -- must disclose the fair present value of a structured settlement to prospective sellers in addition to the discount rate they're applying. The fair present value rate is the Internal Revenue Service discount rate. To account for their costs and profit margins, however, factoring companies typically quote discount rates higher than the IRS rate.
Keep or Sell to Reinvest
Barring a pressing financial need for a lump sum payoff, it's probably a bad idea to cash out and reinvest the proceeds. Ken Murray, CEO of J.D. Wentworth, the company famous for its structured settlement TV commercials, cautions that it's "not a good idea if the consumer does not have a legitimate need."
David Kaufman, CEO of Voyant Advisors, raises the question of personal financial discipline: "Can I be financially disciplined?" The implication is if you lack financial discipline or are not a sophisticated investor, don't sell.
Margot Saunders, of the National Consumer Law Center, emphatically states: "My advice is not to sell." Saunders counsels that structured settlements are established to protect the financial interests of recipients. Selling one "is undermining all those goals at a very high cost."
If you need to sell your settlement cash flow, get all the details upfront, check out the reputation of the factoring company, and get multiple quotes to get as close to the IRS rate as possible.
Investing in Factored Structured Settlements vs. Other Investments
According to a "Retirement Weekly" article of Aug. 5, 2011, factored settlements can earn a tax-free 6.0 percent to 6.25 percent rate with fixed payments for 20 years, guaranteed by an "A" rated insurance company. For the week of Aug. 1, 2011, the average yield on U.S. investment-grade corporate bonds was 3.51 percent and the 10-year U.S. Treasury note was trading around 2.5 percent.
"Factored" is used in the definition to signify a secondary market for structured settlements. The secondary market adds another layer of fees, and another level of risk.
The largest risk is the lack of liquidity. There is no tertiary market for factored settlements. When you purchase a factored settlement, you're more or less stuck with it. Unless you're content with illiquidity, you might want to consider other investments.
Peter Vodola, a partner in the law firm of Seiger, Gfeller, Laurie LLP, warns that factored settlements, which he calls a relatively new type of investment, "still could face unanticipated future legal challenges."
Do the Proper Diligence Before Buying
Get legal and accounting help before investing. Check the factoring company for complaints. Do business directly with top-rated insurance companies only. Have your accountant or tax attorney determine if tax-free benefits apply to your investment.
George Boykin started writing in 2009 after retiring from a career in marketing management spanning 35 years, including several years as CMO for two consumer products national advertisers and as VP for an AAAA consumer products advertising agency. Boykin mainly writes about advertising and marketing for SMBs.