When a case is settled or judgment rendered, decisions must be made about what to do with the money. If the victim was a child, and the money is significant, a judge will have to approve those decisions (in almost every state). Usually the child's money will be used to purchase an annuity that will fund a structured settlement, which is a tax shelter that makes installment payments to the child upon attaining the age of majority. A structured settlement is far and away the most common and best choice, meaning that using the money for an annuity is the norm, but in some cases an UTMA account is possible. In rare cases where the settlement is extremely high, the funds might be put into a trust managed by a paid, professional trustee and invested in a number of things including United States Treasury obligations. In other cases, equally rare, the money is best put into a special needs trust.
This article is going to focus on the relative advantages and disadvantages of an UTMA account versus a structured settlement funded by an annuity. An UTMA account is a custodial account defined by the Uniform Transfer to Minors Act (UTMA) for the purpose of holding cash and other assets gifted to minors. The child named as the owner of things in the UTMA account cannot access them until turning age 18 or 21, whichever age the child's resident state dictates (see The Age of Majority (and the UTMA Account Distribution Age) In Every State.) Upon attaining majority, however, the child will have unrestricted access to everything in the account, without limitation.
There are just a few states where a minor's settlement money can be put into an UTMA account. In other states, however, courts will not approve UTMA accounts and therefore the child's money cannot be put there. When an UTMA account is not allowed or not desireable, a structured settlement funded by an annuity is the usual choice, so the article will compare these two choices. As you will see, the key difference between an UTMA account and an annuity is that an annuity allows parents to "structure" the payments to their child, as opposed to an UTMA account which drops every penny of the settlement on the child upon turning the age of majority.
Advantages of an UTMA account
- Parents can (and have to) manage the child’s money in very safe investments, such as going from a certificate of deposit at 2% interest to one at 3% interest if interest rates go up.
- The money can be used for things like the child’s medical expenses up to age 18 stemming from the accident, but nothing else except what UTMA allows.
Disadvantages of an UTMA account
- Most judges will not approve of putting a minor's money into an UTMA account.
- The child will receive all of the money at age 18 (or age 21 depending on the state law), and therefore might spend all of the money immediately and/or unwisely.
- The funds in the account can prevent a student from receiving financial aid.
- The interest is taxable at the child’s rate.
- The parents or a court-appointed guardian may be required to file a report with the court every year until the child reaches the age of majority.
- The parents may be required to post a bond, which will cost them a premium every year.
- The parents may be required to file a tax return for the child every year, which may require hiring an accountant.
- Interest rates might be lower when the money has to be reinvested.
- If money is lost, badly invested or spent on something not permitted by the UTMA laws, the parents can be sued or criminally prosecuted. (See If You Spend Your Child's UTMA Money, You're Probably Breaking the Law.)
Advantages of an annuity
- In most states, it is not possible to put a minor's settlement money into an UTMA account because the courts insist upon a structured settlement, and an annuity is the usual source of the funds for the structured installment payments.
- The child's money which goes into the annuity will be paid with "interest" in installments over a number of years, and the parents will decide the amount of each installment and how many years it will take to pay out all the money. (The decision is made at the time of the settlement).
- The annuity installments are fixed in time and amount, and cannot be changed. The interest rate also cannot be changed.
- There are no fees or costs to be paid in the future, and no tax on the interest of the annuity.
- The child's anticipated medical expenses and counseling fees can be held outside the structured settlement so money will be available for these things between the date of settlement and the date of majority.
- It is known intuitively and statistically that it is sheer folly to give an 18-year-old or even a 21-year-old a substantial sum of money, because in almost all cases they will waste it. That doesn't happen with structured payments from an annuity because the child's money is paid in installments instead of all at once.
- Spreading payments over several years gives the child a while to learn how to spend the money wisely (or save it). A kid doesn't get that chance with an UTMA account because all the money is paid at once.
- Spreading payments over the so-called "college years" can help kids get a college education that could change their lives for the better.
- Once the court approves purchasing an annuity, the parents are off the hook. Having neither custody of the child's settlement funds, nor the responsibility of investing them, the parents are relieved of legal liability and cannot be investigated, sued or prosecuted for any unfortunate decisions which otherwise might be made.
- Parents have no way of knowing who their child's boyfriend or girlfriend might be at age 18 or 21, and whether that person might swindle or take advantage of their child. If it happens with an UTMA account, the entire settlement could disappear. On the other hand, if it happens with one installment payment from the annuity, the other installment payments will still be there when the time comes.
- Parents also have no way of knowing what will be going on in the future -- what popular political movement, social trend, spiritual organization -- might seize their child's devotion and money during the impressionable teenage years or early adult years. Their child will have unrestricted access to the entire settlement on the day of majority, meaning the ability to spend all of it on something which might be regretted later.
- In short, an 18-year-old or even 21-year-old with a large bank account holding significant money is likely to be tempted to do exactly the opposite of what the parents had in mind rather than go to college and learn to study hard and work hard. The settlement money could actually have a negative effect on the child rather than a positive one.
Disadvantages of an annuity
- The installment payments cannot be changed in amount or time.
- The rate of return will not go up or down.
Who to talk to about an UTMA vs. an annuity
The annuity referred to in this article is the special annuity for accident victims, not any ordinary annuity. It is a special annuity for accident victims that complies with the laws pertaining to personal injury cases involving minors, as well as the Internal Revenue Code's provisions about structured settlements. This special annuity functions as a tax shelter, making the interest on the injured child's net settlement money completely tax-free. Additionally, there are no fees, costs, hidden charges or anything of the sort.
Unfortunately, financial advisers, bankers, accountants and the like have no experience with these annuities, or very little experience with them. The only people who work with them are attorneys who represent victims or defendants in personal injury cases, insurance adjusters, and brokers who deal in them (referred to as "structured settlement specialists"). Therefore, plaintiffs and defendants need to be guided by their lawyers who in turn will work with the insurance adjusters and brokers.
For detailed information about using annuities to fund a structured settlement, including the actual Internal Revenue Code sections, see Structured Settlements in Dog Bite Cases.