Cashing Out A Structured Settlement
David has a daughter with a structured settlement as a result of her mother's death. She wants to buy a house as a single mom. Should she cash out the settlement and take the lump sum?
QUESTION: David in Kansas City has a daughter with a structured settlement as a result of her mother’s death. It’s paying out in increments. She’s 21 and wants to buy a house as a single mom. Should she cash out the settlement and take the lump sum? Dave tells David he has to weigh the ramifications of cashing it in early and how big the hit will be.
ANSWER: You’d have to sell the settlement. The insurance company on a wrongful death or a settlement of this type is not going to cash it out. It would be very unusual if they will. If you sell it out, you’re selling it out at a discount. What you have to be very careful of is how deep the discount is. There would be nothing wrong with getting a buyout of a structured settlement so long as the discount’s not so deep that you wished you hadn’t done it. That means that if you had taken the money slowly and invested it well, would you have ended up with a lot more?
There’s a process and a financial formula called a discount rate, which would be the equivalent in this case of what interest rate she could earn were she to invest the money. You just don’t want a discount rate of higher than 8–10% i something like this. That rate is not that they discount the total by 8–10%. t’s a formula that’s stuck into the program. The 8% i stuck into a formula that’s going to discount that depending on how long the time is. It could discount it almost in half in terms of the total. The longer the term, the deeper the cut is going to be of the total.
You’re going to see a pretty good hit on that, because if you took a lump sum today and invested it, how much would it be by the time she’s 47? That’s the concept. It’s called present value. Would you rather have $100,000 today or $100,000 when she’s 47? I’d rather have it today because of all the interest I could earn in the meantime. That’s the crux of this formula. You’re going to see with that long of a structured settlement a pretty deep cut.
I would sit down with a financial person and crunch the numbers. I’d shop around with what you’ve got to some of the companies that buy out these settlements and see what kind of offers you can get. Talk those over with the ELP, and crunch the numbers to see how bad a hit she’s taking. I’m a little nervous about a 21-year-old getting a big hit, but if she’s got her head screwed on good, then it’s not a problem. Buying a house is certainly a good thing to do with it.