We have many attorney clients. Some of them came to us when they were originally considering a structured settlement. But they subsequently determined that a cash balance plan would make more sense.
Normally, legal settlements are received as a lump sum, which can create a significant tax liability. One solution to consider is a cash balance plan, which can offer numerous benefits over structured settlements.
In this article, we’ll explore the key differences between a structured settlement and a cash balance plan. We will explain how, in some situations, the cash balance plan can provide greater flexibility and better long-term financial planning. Let’s get started!
What is a Structured Settlement?
A structured settlement is a financial arrangement in which an attorney receives their fees over time rather than as a lump sum. This type of payment structure is commonly used in cases involving large settlements, such as personal injury or medical malpractice lawsuits.
The attorney agrees to a schedule of payments, often facilitated by an annuity. This approach allows for strategic planning, as income is spread across multiple years instead of being taxed all at once in a single high-income year.
One of the primary benefits of a structured attorney settlement is tax efficiency. Since income taxes are typically based on annual earnings, receiving a large lump sum could push an attorney into a higher tax bracket, resulting in a substantial tax liability. This strategy helps them retain more of their earnings while ensuring a predictable stream of income.
Unfortunately, many structured settlements have high fees and other restrictions that can offset many of the benefits. Some of the benefits of structured settlements are available with a cash balance plan with lower fees and more flexibility.
What is a Cash Balance Plan?
A cash balance plan is a type of defined benefit retirement plan. Cash balance plans allow self-employed business owners to have up to $3.7 million in the plan at retirement. Because of this large amount, you can make very large contributions.
In fact, we have seen clients contribute over $500k into a plan in a given year. Better yet, those contributions are tax deductible and can be used to offset the income from the legal settlement.
Upon retirement, the business owner can either take their balance as a lump sum or roll it into an IRA for continued tax deferral. These plans are widely used by firms seeking substantial tax savings while providing meaningful retirement benefits for owners and employees alike.
A cash balance plan allows attorneys to defer a large portion of their income, reducing their taxable income. Unlike a structured settlement, which typically involves a fixed schedule of payments, a cash balance plan provides more control over retirement savings. It also offers higher contribution limits, helping attorneys save more for retirement while benefiting from tax deferrals.
Structured Settlement Questions
Structured settlement can be uniquely structured. But there are many questions that must be answered:
- What are the structured settlement interest rates?
- How do I find reputable structured settlement companies?
- Is there a calculator available?
- Are they the same as annuity settlements or structured settlement annuity?
- Are there any structured settlement examples I can review?
Finally, structured attorney settlements offer customization and flexibility. Attorneys can work with financial planners and insurance providers to design a payout schedule that aligns with their financial goals. Payments can be scheduled monthly, quarterly, annually, or even with deferred lump sums for future milestones like retirement.
Additionally, these arrangements are typically backed by highly rated insurance companies, ensuring financial security and peace of mind. Overall, structured attorney settlements provide attorneys with a strategic way to manage their income, taxes, and financial future effectively.
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Structured Settlement Examples
Let’s say an attorney wins a large personal injury case on a contingency basis and is entitled to a $1 million fee. Instead of receiving the entire amount in a lump sum, they choose a structured attorney settlement to spread payments over time.
The attorney works with a structured settlement company to set up a payment schedule. They agree to receive $200,000 per year for five years, with payments funded through an annuity. This arrangement helps reduce their tax liability by avoiding a massive single-year income spike that would push them into a higher tax bracket.
But let’s assume that same attorney uses a cash balance plan. It still can make sense to divide the income up into two years. So, let’s assume that the attorney negotiates the settlement by receiving half in the first year and the remaining $500k in year two.
Depending on age and tax structure, let’s assume that the attorney made a $250k contribution to a cash balance plan and the same amount in the second year.
Benefits of Using a Cash Balance Plan Compared to a Structured Settlement
Both the structured settlement and a cash balance plan will act as a tax deferral. This means that the income will be deferred and taxed at some point in the future. Presumably, you would be in a lower tax bracket at some point in the future when the income is taxable.
But while there are some similarities, there are many differences in these two types of structures. First of all, a structured settlement just takes the entire settlement and divides it up into a specific number of years. Thus, spreading out the tax liability to the years in which the income is received.
However, a cash balance plan works a little differently. It is a retirement structure. So, the client will reflect all the income from the settlement at the time of receipt and not spread it out over a number of years. But the client is taking an additional tax deduction relating to the cash balance plan that will mitigate the overall tax liability. The funds in the cash balance plan will be drawn at retirement, or it will be terminated and rolled over into an IRA.
Is a Cash Balance or Defined Benefit Plan Right For You?
Both structures can work depending on the situation. But they’re very different types of tax strategies.
Bottom Line
A cash balance plan offers attorneys greater tax advantages, higher contribution limits, and more control over their retirement savings. Unlike a structured settlement, it allows flexible contributions and long-term wealth accumulation. Attorneys can significantly reduce their taxable income while securing a stable financial future.
Choosing a cash balance plan over a structured settlement can be a smart financial move. It provides attorneys with greater flexibility, substantial retirement benefits, and long-term security. For those seeking tax-efficient wealth growth, a cash balance plan is a powerful tool worth considering.
