Q: My husband has a structured settlement from an accident he was involved in as a child. He sold ten years of that settlement in 2004, but in 2014 he'll start receiving monthly payments of $400. We have approximately $30,000 of debt, including medical bills, and we lease our only vehicle. These days we are having difficulty making payments on time. There is literally $1 in our savings account. We have a 7-month-old son and hope to buy a house within the next few years. We think that selling the rest of the settlement to pay off our bills will allow us to save for the home of our dreams. There's about $110,000 left; by selling it, we'd net $17,500. Would that be smart?
A: Structured settlements are a common way for people who have been injured to receive an insurance payout. The periodic payments provide ongoing income and reduce the risk of blowing a lump sum through poor financial choices. In many states, you can sell your rights to periodic payments to a company that will pay you a lump sum today. Doing so, I realize, is tempting, but it's typically not smart.
For starters, payments received in a structured settlement are generally tax-free; if you sell in return for a lump sum, you may owe state and federal tax, thus reducing the settlement's value. More important, the firms that buy your settlement are out to make money by underpaying you for its real value. The bottom line: Cashing out today can mean netting far less than you'd get if you kept the payments.
Let's do the math. Since you owe $30,000, a $17,500 payout isn't going to solve your problems. You would still have $12,500 in debt, and a car lease, and you'd be no closer to building a savings account, let alone coming up with the down payment for a home. I want you to dig out of debt without touching the settlement money. Your dream should be to get out of debt, not to buy a home that you have no way of affording right now.
If you need help tackling your bills and learning to live within your means, I suggest you contact the National Foundation for Credit Counseling, a nonprofit organization that will connect you with a debt counselor in your area ( NFCC.org ; 800-388-2227). NFCC counselors will assess your situation, help you negotiate payment plans with your creditors when feasible, and, yes, tell you if cashing in your settlement is your best move.
I also want you to focus on what those tax-free settlement payments can do for you beginning in 2014. It sounds as though you have 20 more years of payments coming to you. If you were to invest the entire $400 every month in a Roth IRA for 20 years and earn a conservative 5 percent annual return, you would have about $165,000 in 2034. If you were to keep that sum growing for another 15 years—without investing another penny—you could have more than $340,000 by the time you retire. That's a dream that can be yours if you use the structured payouts wisely.
Suze Orman's most recent book is her 2009 Action Plan: Keeping Your Money Safe & Sound (Spiegel & Grau).