by John Darer CLU ChFC MSSC CeFT RSP CLTC
If You Bank It, Don't Bank on Maximum Financial Aid
Parents or guardians of minors who are receiving a settlement in a personal injury or wrongful death case, should give due consideration to how the settlement will impact the ability to receive financial aid for college. Having a lot of money in a bank account, or in a CD coming due at age 18, could reduce or even eliminate, the possibility of receiving needs based financial aid. Depending on the school, the FAFSA (for federal student aid) or CSS Profile (for institution based student financial aid) may be used. Each of those forms requires a significant percentage of student assets be used in its calculation of Expected Family Contributions (EFCs). At present that is 20% for FAFSA and 25% for the CSS Profile.
Structured Settlement Annuity is Not an Asset of Minor
A structured settlement annuity is not an asset of the minor. The structured settlement annuity is owned by a qualified assignment company in most cases. In rare instances it is owned by the Defendant or Defendant's insurer. The minor only has the right to receive payments when due and would have had no control over the establishment of the structured settlement. Furthermore, in accordance with terms of the structured settlement and in compliance with tax code, the periodic payments cannot be accelerated, deferred, increased, or decreased, by the recipient of such payments". [ see IRC 130(c)(2)(B)]
Tax Difference Between Structured Settlements and CDs
Damages for personal injury or wrongful death are income tax free, subject to IRC 104(a)(2). While a lump sum from a personal injury or wrongful death settlement would be income tax free, the interest on a lump sum invested in bank CDs would be taxable. So, for example if you have a 12 year old son and invest in a 5 year CD with Barclay's at time of posting, it would earn 2.75%. The 2.75% would effectively be reduced by the tax on the interest, which could be inflated if there is a kiddie tax [ See below and Taxable Equivalent Yield | What is The Value of the Structured Settlement Tax Benefit?]
Kiddie Tax Impact
The interest on a minor's personal injury or wrongful death settlement could be taxed at a high rates if invested in CDs, or other taxable investments. The Kiddie Tax is applied to the amount of the child's unearned income that exceeds $2,100. The Kiddie Tax rate is parent's or parents' marginal tax rate (the highest rate applied to the last dollar earned) which could be as high as 37%, for the 2018 tax year. [ see IRS Topic 553 Tax on a Child's Investment and Other Unearned Income (Kiddie Tax)]
Notwithstanding the above, there is substantial risk of wasteful dissipation in making a large sum of cash available at age 18. A teenager or young adult could benefit from wealth orientation by speaking to a Certified Financial Transitionist.
Read more about Structured Settlements for Minors