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When Should You Purchase An Annuity With A Legal Settlement?

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If you've recently been awarded a legal judgment or settlement through a personal injury, medical malpractice, or other tort lawsuit, you may be wondering what to do with these funds. You may need a sizable portion of your judgment or settlement monies to pay medical bills or other costs stemming from your accident, or to help pay off debt incurred while you were out of work. However, you may still have money left over -- particularly if you were awarded punitive damages. What should you do to avoid squandering these funds? Read on to learn more about how annuities work, as well as when the purchase of an annuity might help you wisely manage a cash settlement.

What is an annuity?

An annuity is a type of savings vehicle that provides a guaranteed future income in exchange for an initial lump sum investment. Many individuals seek annuities in retirement, cashing out a 401(k) or other potentially volatile investment to purchase an annuity that will provide a steady, guaranteed stream of income for the rest of the individual's life. 

Annuities generally don't have a survivorship provision -- so if you take out a 25-year annuity and pass away after receiving payments for only 10 years, it's unlikely your surviving family members will receive any portion of your initial investment. However, annuities are much safer than investments with similar returns, and you'll be able to plan your future knowing that you have at least a minimal amount of guaranteed income. 

When is purchasing an annuity with settlement funds a good idea?

In many cases, the physical harm caused by the accident leading you to file a personal injury is ongoing and may require follow-up treatment even after the legal case is over. If you're facing many more years of medical bills, an annuity may be a good way to provide you with some return on your funds (and enough cash to pay any bills that come in). While keeping the money in cash could tempt you to spend it on other purchases, and investing it in the stock market could require you to withdraw funds during a dip, an annuity will provide you with a regular infusion of cash to pay any bills.

You'll also want to consider tax advantages when purchasing an annuity with personal injury settlement or judgment funds. In general, funds received for physical injuries are non-taxable -- however, funds received for lost wages or punitive damages may be taxed. If this is the case, you'll want to pay any applicable taxes before purchasing your annuity so that your regular annuity payments can remain tax-free upon receipt.