Structured Settlements and Minor Children
In the event of an accident involving a minor child, the responsibility of determining the fairness of the settlement lies solely with the court. The judge assigned to the case is obligated, by law, to protect the child’s interests, as well as all funds obtained in the child’s settlement agreement. As a result, the court almost always prohibits excessively risky investments of a child’s settlement funds. Currently, there are three commonly accepted options for preserving a minor’s settlement: 1) a guardianship account; 2) a trust, and 3) a structured settlement annuity.
There are positive and negative aspects associated with all three. Because structured settlement annuities are easily maintained and offer favorable financial returns without ongoing fees, they are commonly the preferred option for preserving children’s settlements. It is important to keep in mind that structured settlements can be used in combination with a trust or guardianship account to achieve the ideal provisions and meet the desired goals of every, individual case.
If a child receives a lump-sum settlement, the money from that settlement must be placed into a guardianship account (also called a conservatorship in some states) or a trust. A guardianship account is just another term for a “protected” or a “restricted” bank account. Usually, they are sound investment accounts, like a money market account. As such, they typically yield a modest rate of interest and require annual fees for filing, taxes, and accounting.
The court maintains a measure of control over the account and requires the submission of an annual report of the settlement proceeds subsequent to the accounting and tax filings. Guardianship accounts, as implied by their name, are overseen by court-appointed guardians. The individual charged with the task could be a parent, a professional guardian appointed by the courts, or another attorney. While guardians are responsible for the annual reporting and accounting of the minor’s settlement funds, they have very limited control over the money. Any changes made to the account, including distributions from the account, must first be approved by the court. Guardianships/Conservatorships are typically the most expensive to establish and maintain for minors and are the most tedious when a distribution is required.
A trust is a separate legal entity that holds property or assets of some kind for the benefit of a specific person, group of people or organization known as the beneficiary. There are several varieties of trusts, all of which serve a wide range of purposes. With any trust, there is a trustee, who is responsible for managing and maintaining the trust. Trustees have a legal duty to administer a trust’s assets in the best interest of the trust’s beneficiary. The exact responsibilities of a trustee, as well as the amount of access a trustee has to a trust’s funds, ranges greatly and should, therefore, be specified in the trust.
When establishing a trust for a minor child, Special Needs Trusts (SNT) or Settlement Trusts are most often chosen to best protect the child’s settlement and interests therein. SNT’s, specifically, are used to preserve a minor beneficiary’s preexisting Supplemental Security Income (SSI) or Medicaid benefits. Often, an inheritance or a financial settlement is considered an asset that disqualifies recipients of SSI or Medicaid from continuing to receive their benefits. SNT’s not only indemnified beneficiaries from losing their benefits but also account for all care and assistance not provided by the beneficiary’s public assistance funds. Similarly, Settlement Trusts are established to provide for a minor beneficiary’s needs as they arise. In addition, they protect against dissipation of the settlement funds. Settlement Trusts typically yield a conservative interest rate and are managed by a trustee who is held responsible for the mandatory accounting that is to be reported to the IRS annually.
The trust documents specify how the funds can be used for the minor’s benefit while he is under the age of 18 and how the funds will be disbursed once the beneficiary reaches the age of 18. The payout can be arranged as one lump sum or it can be disbursed in installment payments over a period of time. There are fees associated with the establishment and administration of both Special Needs Trusts and Settlement Trusts. Because the circumstances surrounding every trust are unique, the fees vary.
Both forms of trusts, however, are required to pay annual income taxes on gains within the trust. In the case of Preservation Trusts, the court sometimes waives the requirement for a legal guardianship, as well as the submission of an annual report. The investment returns on Preservation Trusts depend on market conditions. The financial advisor who sets up the trust provides the trustee with a “best guess” of how the trust will perform before the trust is officially established. This guess is based on the past performance of investments similar to that of the respective trust. As with any investment, the trust may perform better or worse than anticipated. However, because Preservation Trusts are typically invested in conservative mutual fund portfolios or bond portfolios, the return on it should not vary dramatically. Thus, they are regarded as low-risk investments.
Structured Settlements are the most popular option for settlements involving minor children because they allow personal injury victims to receive tax-free payments from their settlement over an extended period of time. Like Special Needs Trusts and Preservation Trusts, Structured Settlement Annuities typically yield between 3% and 10%. However, they differ in two significant ways. First, unlike trusts, Structured Settlements offer a guaranteed return interest rate. This means that the projected returns will not vary, and the financial illustration provided at the annuity’s inception will perform as stated. Second, there are no ongoing maintenance or management fees associated with Structured Settlements so this is almost always the lowest cost option.
The payout schedule is determined during the negotiations of the settlement and corresponding documents are drafted. In most cases concerning children, the payments begin when the beneficiary turns 18 years old. Often parents elect to set up the payments so that they pay the beneficiary in regular intervals over an extended period of time. This approach not only prevents dissipation but also provides for future needs and wants, such as medical expenses, college expenses, a car or even a home.
Payment schedules must be established before the settlement is concluded. Once decided upon, the payout schedule becomes permanent and unchangeable for the life of the annuity. Structured Settlement payments can be set up to disburse in periodic installments over a specified timeframe, in lump sums or even in a steady stream of the course of the beneficiary’s entire lifetime. The establishment of a structured settlement is very specific to its purpose. A parent or legal guardian cannot simply take a lump settlement and purchase a tax-free annuity. There must be special language in the settlement documents citing the establishment of a tax-free annuity in conjunction with a court order authorizing the structured settlement. These steps must be finalized prior to the settlement documents execution.