66-year-old Deborah Danner was shot twice in the chest in the bedroom of her Bronx apartment in 2016 by Sergeant Hugh Barry.
Danner was armed with a bat.
Barry was later indicted and found not-guilty of murder but remains on modified duty while awaiting a departmental disciplinary hearing.
The city Law Department released the following statement: "The City has agreed to a settlement with the family of Deborah Danner, a person who struggled with mental illness, tragically killed in an encounter with police. We carefully considered the facts impacting the civil claims against the City, including the criminal indictment of a responding officer and the disciplinary charges pending against him. This agreement is a fair resolution of a tragic case and hopefully it brings some measure of relief to the family. The City is committed to preventing these tragedies from happening."
Danner suffered from schizophrenia, and her sister called police to the apartment after the two had an argument.
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