My Child Is Getting A Settlement, What Happens To The Money? (Part 2 of 2)
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There is one final settlement option for children with regards to personal injury or car accident settlement. A structured settlement is an option that provides a financial planning component that parents are often interested in using. A traditional settlement, is a settlement that is issued in one lump sum check. That check is then held in an attorney’s trust account until a court authorizes the distribution. At that point the funds will generally be deposited in a bank account.
Depending on the amount of settlement proceeds, the bank account may be in the minor’s name only, or be controlled by someone appointed by the court, usually a parent or grandparent. The child and his or her parents know where the money is and in case of an emergency medical bill related to the original injury settlement, the court, in its discretion, can approve a disbursement of the money and it can be withdrawn from the bank.
A structured settlement does operate in this way. When a structured settlement is set up it is funded with the settlement proceeds. Those proceeds are used to “purchase” future payments for the child. To regulate these payments, an annuity contract is formed. In the contract the parent or legal guardian can indicate when the money is to be paid to the child, and it doesn’t have to be released in one lump sum when the child turns 18.
In a traditional personal injury settlement arrangement, when the child turns 18, they can go down to the bank with their ID and withdraw all of the money. In some cases this amount can be worth hundreds of thousands of dollars. Giving an 18 year old access to that kind of money is dangerous for obvious reasons, and the parent, guardian, or the court for that matter, has no legal right to intervene.
A structured settlement allows the parent a little more control, but there are some draw backs. In a structured settlement contract, a parent can decide the future dates the payments are to be made. For instance, it is common to see payment plans that disburse a certain lump sum at age 18 funded with 10% of the money. Then, another certain lump sum at age 21, funded with 20% of the money, and so on. Plans can be tailored to suit almost any need. The annuity is purchased as a “qualified funding asset” in compliance with IRC§130(d) by the qualified assignment company. Payments from structured settlements enjoy favorable tax status due to tax exclusions on damages for personal physical injury or, physical sickness, workers compensation or wrongful death, subject to IRC §104(a)(1) or IRC §104(a)(2). While the lump sum from a cash settlement may be income tax free for the physical injury or sickness, wrongful death or workers compensation, interest earned on the lump sum may be taxable.
In the structured settlement, obviously the longer the money is left with the company, the more interest is paid. I have seen options that pay a small monthly amount to the “child” starting at age 18 and continue to make payments until the money runs out. I have seen others that make a large payment for four years during the years the child would likely be in college. The drawback to this option, is that once the payment contract is signed by the parent, it cannot be changed. If an emergency arises where a judge would have, in a traditional settlement, authorized a withdrawal of some of the settlement money, this cannot happen. In fact, neither the child nor the parent owns any of the money. Instead, they own a promise of payments to be made on scheduled dates. Despite these drawbacks, a structure settlement is often advised for children. Not only do they accrue tax-free interest, but they protect the child from being seduced into thoughtless spending once they turn 18 and receive a large sum of money.