A settlement can completely transform your financial situation, and often those who get a significant financial windfall through a settlement express regret years later because they made the wrong choices in the first three months. These choices are so impactful that they can continue to affect your finances for decades after the fact. Money that comes from injury claims, wrongful death cases, workers’ compensation, and similar sources rarely arrives at a convenient time for making long-term decisions. Those receiving these settlements are often still grieving, recovering, or otherwise coping with a difficult situation, leading to them making decisions that lead to regret. Thankfully, following some simple ground rules can help you to make financial decisions that will work for you over the years.
Financial Planning After Settlement
Before you commit to a major financial decision, you should avoid any large purchases, investments, or loans for the first three to six months. Delaying these decisions gives you the chance to think about what you’re doing without being distracted by the pressures of the case. In the meantime, you should keep your money in a secure, FDIC-insured account. A large balance might need to be split across banks or held through a program that extends coverage.
Know What You Actually Keep
The gross figure is rarely the settlement figure that you actually keep. The following costs can build up and reduce the amount you’ll actually see:
- Attorney fees
- Case costs
- Medical liens
- Reimbursement claims from insurers
You should ask your attorney for a written accounting of every deduction before you start to make plans.
The taxes you’ll pay frequently depend on the type of compensation. Damages for physical injury or sickness are generally excluded from federal income tax, but the following types are not:
- Punitive damages
- Interest
- Employment-related awards
- Emotional distress damages, unless they stem from a physical injury
Remember that state rules may vary, so always check for yourself.
Get the Right Advisors
Three advisors can help you work your way through these difficult processes, and which ones you depend on will vary with your situation:
- Your attorney explains the settlement terms, your obligations, and how you can use the funds.
- A fee-only fiduciary planner is legally bound to put your interests first.
- A CPA confirms what’s taxable and helps you develop a plan for routine payments.
Weigh Structured Settlement Factoring Options Carefully
If your settlement pays out over time, someone will likely eventually offer to buy those future payments for instant cash. This can be a big mistake. Before you sign anything, understand your structured settlement factoring options and what each one costs. Depending on the terms, a factoring company that operates this way will always pay you less today than the payments are worth in total.
That’s how they make money, by giving people access to cash immediately at the expense of a proportion of the total. The terms can differ drastically, and sometimes the amount is justifiable, but sometimes these companies offer incredibly low rates bordering on predatory. For this reason, many states, along with federal law, penalize transfers that a court has not approved, so you’ll need to get official approval to legally claim these funds.
Expect Requests From Friends and Family
One of the most unexpected outcomes of getting a significant settlement is the attention you’ll get from friends, family, and acquaintances. Sadly, people often don’t realize how these settlements work, and many will think you’re getting the full amount deposited into your account immediately. This means family members might start asking for loans or financial favors, thinking you’re in a much better position than you actually are.
Financial disputes are one of the main causes of estranged families and fizzled-out friendships, so you’ll need to make sure you can explain yourself if you’re put on the spot.
Having a financial plan in place can help you to bypass these questions because you can truthfully say that your money is committed to your plan and that you need to review any large decisions with your financial advisor, keeping the refusal impersonal and making sure that the person requesting it doesn’t lose face.
Make Your Settlement Last
Receiving a settlement is a major turning point, and the choices you make early on will still affect your finances years down the line. That’s why you should give yourself time before making any large commitment, make sure you understand how much you’ll actually keep after fees, liens, and taxes, and lean on professional advisors who put your interests first.
If someone offers instant cash for your future payments, remember that you’ll always receive less than those payments are worth. If you’re interested in learning more about similar topics, see our article archives for more.
