Structured Settlement Annuities – Advantages and Disadvantages
Personal injury attorneys are well aware of the benefits of structured settlement annuities and the role they play in settling a personal injury claim. Notably, structured annuities are an excellent vehicle to ensure that an injured client will have guaranteed income for a defined period of time or even their lifetime. Structured settlement annuities also prevent premature dissipation of settlement recoveries by clients who may be ill-equipped to manage large sums of money. Additionally, if the settlement is on account of personal physical injuries, as defined in IRC §104(a)(2), the income stream (both principal and interest) from the annuity is completely exempt from federal and state income taxes, and there are no ongoing management fees.
However, as with all financial products, structured settlement annuities have some important disadvantages. Perhaps the principal disadvantage of structured settlements is their inflexibility – an injury victim cannot change the annuity design or request that the annuity be liquidated, except in extreme circumstances when it is ordered by a judge that it is in the best interest of the client to do so, per IRC §5891. This inflexibility means that a structured annuity is not an appropriate vehicle to fund needs or goals with uncertain future dates with uncertain amounts.
Settlement Trusts – Advantages and Disadvantages
Settlement trusts fill the void left by structured annuities – namely flexibility and liquidity while still providing some level of dissipation protection. Often an injured client will have various needs beyond the need for guaranteed future income. These needs often include a new home purchase or renovation of existing home, future college tuition payments, future surgeries or medical procedures, or any number of other unforeseeable future contingencies. Such future needs are impossible to know at the time of settlement and are thus well suited to a settlement trust that offers such flexibility. Settlement funds inside the settlement trust are best managed by an independent corporate or other qualified trustee.
Additionally, settling clients often have concerns about losing eligibility for government entitlements such as Medicaid and SSI. A Special Needs Trust (SNT), a specific type of settlement trust, allows the client to remain eligible for Medicaid and SSI benefits while the funds within the SNT are used to pay for “supplemental” needs that are meant to enhance the client’s quality of life. There are specific rules for establishing and maintaining a SNT, and generally a qualified attorney should be retained to advise the client and draft this type of trust.
The disadvantages of settlement trusts generally have to do with the cost to establish the trust, the ongoing trustee, maintenance, and asset management fees, and the non-guaranteed nature of the trust principal. Even the most progressive and client-friendly corporate trustees will rarely accept a settlement trust under $50,000, and generally charge a trustee and management fee of at between 1-2% per year. These fees make trust planning for smaller settlements particularly difficult. Additionally, while trust assets are generally invested very conservatively, the principal amount placed inside the trust is not guaranteed and may lose value, and any interest earned inside the trust is fully taxable.
How to Maximize the Advantages and Minimize the Disadvantages
Structured settlement annuities can be established to pay directly into a settlement trust, thus incorporating each option’s respective advantages while minimizing their respective disadvantages. For example, a catastrophically injured client will often require guaranteed lifetime income to ensure basic funding for his/her lifetime care. The client will also require significant flexibility to pay for future unknown medical and life expenses, and may require the need to remain eligible for Medicaid and SSI. Structuring future payments into a settlement trust or special needs trust allows the client the peace of mind offered by a guaranteed, fixed, tax-free annuity, while the trust offers the flexibility and liquidity to meet the client’s ever-changing life situation.
Attorneys representing clients that have both guaranteed income needs and the need for liquidity and flexibility have a duty to retain a competent settlement planner that can advise the client regarding their options and offer both structured settlement annuities as well as provide settlement trust options that meet the comprehensive needs of most injured clients.
At Amicus, our goal is to be the plaintiff bar’s premier, comprehensive resource for all of the financial and legal issues that arise at the time of settlement. With Amicus, you don’t need to call one firm for a structured settlement, another for a special needs trust, and another for asset management. We can handle all of these in-house. Give us a call on your next case and see how we can help.