Willy Buchel, 95, was the first ex-prisoner of war to receive such a payment, his lawyer said on Tuesday.
Mr Buchel filed a lawsuit in May last year over the mental anguish suffered in the years after the 1945 bombing, lawyer Hidekazu Zaima told AFP.
He will receive 1.1 million yen ($9,640; Â£6,910).
Mr Buchel was in a prison camp 1.7km (one mile) from ground zero on 9 August, when the bomb detonated over the south-western Japanese city, killing more than 70,000 people.
He returned to the Netherlands in 1950 and was not able to receive full medical coverage provided to Japanese survivors of the bomb, Mr Zaima said.
According to Japan's Kyodo News, Mr Buchel said in the lawsuit he "was forced to continue living while suffering from peculiar health damage caused by his exposure to radiation".
Mr Zaima told a news conference that the unprecedented settlement was of "grave importance".
Japan started providing overseas atom bomb victims with medical allowances in 2003. Before that, a 1974 ruling said funds would be stopped if victims travelled out of Japan.
The Nagasaki bomb followed one dropped three days before on the city of Hiroshima, where about 140,000 people are estimated to have been killed by the blast or later by radiation sickness.
A Dutch former prisoner-of-war held in Nagasaki when the US dropped an atom bomb on the city has won compensation from the Japanese government.