News
Probate
Aug. 12, 2002
Use of Annuities Is Effective for Structured Settlements
Focus Column - By William L. Winslow - Structured settlements that use annuity-funded periodic payments are now a regular feature of large personal injury and workers' compensation settlements. Appointment of a fiduciary is a requirement in nearly every case of serious injury to a minor and in perhaps half of the cases involving an adult.
Focus Column
By William L. Winslow
Structured settlements that use annuity-funded periodic payments are now a regular feature of large personal injury and workers' compensation settlements. Appointment of a fiduciary is a requirement in nearly every case of serious injury to a minor and in perhaps half of the cases involving an adult.
• The available options. For minor's settlements involving six figures or more, it is usually preferable for the court to appoint a fiduciary. A blocked account won't do - it is essentially below the standard of care - if the minor's welfare depends on regular expenditures post-settlement. If the evidence shows the advantage of such things as attendant care, regular doctor's visits, medications or special schooling, a blocked account is hopelessly inefficient.
There are three different fiduciary options for the receipt of minor's settlement proceeds under the Probate Code: a special needs trust, a statutory minor's trust and guardianship of the estate. All three require that the fiduciary be bonded and regularly account in writing to the court.
A litigation special needs trust (Probate Code Sections 3600, 3602(d), (f), 3604, 3611(c)) should be used if the minor must remain eligible for Supplemental Security Income or Medi-Cal or might qualify in the not-too-distant future. The court must approve every compromise involving a minor and payment of money. Probate Code Section 3600. The minor's compromise petition should request that the court make findings under Section 3604, establish the special needs trust and appoint a trustee. The attorney should attach the proposed trust. This avoids delay and unnecessary expense for a separate petition.
The statutory minor's trust is the best choice if eligibility for government assistance is not an issue. Probate Code Sections 3600, 3602(c)(3) and 3611(g). Here again, the proposed trust should be attached to the minor's compromise petition.
The third alternative, a guardianship (Probate Code Sections 1500 to 1601), offers no advantages over the statutory minor's trust. It requires an unnecessary proceeding in the Probate Department, separate from the minor's compromise proceeding.
For adults, there are two primary options: a conservatorship of the estate (Probate Code Sections 1800-1969) or a special needs trust (Probate Code Sections 3600, 3602(d), (f), 3604, 3611(c)). If the injured adult is mentally incompetent, one or the other of these two alternatives must be utilized. A conservatorship of the person may accompany either arrangement where the individual also cannot make decisions regarding personal care.
Somewhat surprisingly, a special needs trust can be established, on a proper showing, for a disabled but mentally competent plaintiff. See Probate Code Section 3603 and 1801(a)(1).
The court can appoint a bank or trust company as the fiduciary, or an individual or individuals can serve in any of the fiduciary roles referred to above; but bond will be required. This bond is similar to that required of the executor of a probate estate.
• How much should be structured? Plaintiffs' lawyers may wonder: How much of the settlement should be structured, and how much should be "up-front" cash? A good rule of thumb is to place half of the net settlement proceeds, plus or minus 10 percent, into a structured settlement, with the balance paid to the fiduciary at once.
Suppose the defense has agreed to spend $750,000 on the settlement, and attorney fees, costs and discharge of liens will require $350,000, leaving a net of $400,000. The recommendation is that $160,000 to $240,000 (i.e., 40 to 60 percent) of the net amount be structured and the remainder paid immediately. Nevertheless, some arrangements have functioned reasonably well for years where all or none the funding is structured payments.
Here are some of the considerations underlying the rule of thumb stated above:
• Usually a certain amount of predictable monthly income is essential for this particular category of potential investors - seriously injured persons.
• Tax-free structured settlement payments are preferable to the inferior yields of various debt instruments and cash equivalents, to which a cautious investor normally devotes 25 to 40 percent of the portfolio. A structured settlement annuity cannot be purchased after the settlement.
• Most individual fiduciaries do not have the time or knowledge to engage in sophisticated investing.
• Caveat: The rule of thumb must be adjusted if a residence is to be bought for the injured party. The house purchase should be all cash. Conventional home mortgages are not available to fiduciaries or disabled persons.
• Caveat: If there is a strong possibility of the plaintiff dying within the ensuing two years, no more than 20 percent of net settlement proceeds should go into the settlement annuity. The problem cannot be cured with a long guarantee period.
• Usually the planning focus is on the injured party's needs, not the expectancies of family successors.
• An age-rated settlement annuity, based on the impaired life expectancy of the injured party, offers unparalleled economic performance. The structure can contain a provision for commutation of guaranteed payments if the annuitant dies early.
• If the present value of the structure exceeds $500,000, it should be divided between two companies; if more than 41 million, among three companies, etc.
• Trap for the unwary. A trap for drafters of special needs trusts exists where a structured settlement has a guaranteed period. The trap results from the statutory requirement that a litigation special needs trust must contain a provision mandating reimbursement to the state, on termination of the trust, in the amount that Medi-Cal has paid for the beneficiary's medical expenses during the operation of the trust. (Distinguish this Medi-Cal reimbursement claim from the Medi-Cal lien, which arises from pre-settlement expenses by Medi-Cal on account of the claim-related injuries.)
The plaintiff and the family desire that, in the event the victim dies before the end of the certain period, the remaining guaranteed payments will flow outside the trust directly to the decedent's estate. But if the trust is given the right to receive all structured payments, then the trustee must receive them; and the Medi-Cal reimbursement claim may reach these dollars.
The correct drafting approach requires a departure from the forms generally used for structured settlements. The drafter should first describe the payment format, omitting mention of the payee, and then describe the payee during the annuitant's lifetime (the trustee). Finally, the drafter should describe the payee for any remaining guaranteed payments due after the annuitant's death is named. (Usually this is the estate.)
One criticism of this approach is that it is unfair to the government. But the drafter has a client, a badly injured individual, and does not work for the government. Moreover, under the rule of Lucas v. Hamm, 56 C. 2d 583 (1961), and its progeny, the estate planner owes a duty to prospective family successors.
Another objection is that a guarantee period shifts settlement value away from the victim because a life-only annuity would pay greater monthly benefits. There is some merit to this second objection, but most people use guarantee periods.
• Valuing the structured settlement. Sometimes probate judges or staff assert that the proper way to value a structured settlement right is to have the present value of that right determined and treated as an estate asset. The better view is that the present value of a structured settlement right is not available to the fiduciary and should not be used in calculating bond or trustee's fees.
A structured settlement annuity is owned by the defendant, its insurer or an assignee of both of them, not by the plaintiff or the estate. The trustee has no right in the annuity; he or she cannot accelerate the payments or sell or encumber the annuity. These arrangements are requisite elements of an income-tax-favored structured settlement. See Internal Revenue Code Sections 104(a)(2), 130; Rev. Rul. 79-220, 1979-2 C.B. 74.
It would be a different case if the estate had purchased an annuity. Then it could be drawn upon, sold or borrowed against; and fluctuations in value would affect the estate. A structured settlement is not an investment by the estate; it is more like a pension right or Social Security. One can learn the present value of a typical pension; but because that value is not available, the information is essentially irrelevant.
• Medi-Cal regulations. Structured settlement funding of a special needs trust must conform to some easily overlooked Medi-Cal regulations. 22 C.C.R. Section 50489 et seq. Annuity payments must be "immediate," defined as starting within one year of settlement. The annuity must provide "level" income, but this is given a practical twist: Payments can increase by up to 5 percent per year. The guarantee period cannot exceed life expectancy, and the life-expectancy figure must be that actually used by the annuity company.
William L. Winslow is an attorney at Farmer & Ridley in Los Angeles.
By William L. Winslow
Structured settlements that use annuity-funded periodic payments are now a regular feature of large personal injury and workers' compensation settlements. Appointment of a fiduciary is a requirement in nearly every case of serious injury to a minor and in perhaps half of the cases involving an adult.
• The available options. For minor's settlements involving six figures or more, it is usually preferable for the court to appoint a fiduciary. A blocked account won't do - it is essentially below the standard of care - if the minor's welfare depends on regular expenditures post-settlement. If the evidence shows the advantage of such things as attendant care, regular doctor's visits, medications or special schooling, a blocked account is hopelessly inefficient.
There are three different fiduciary options for the receipt of minor's settlement proceeds under the Probate Code: a special needs trust, a statutory minor's trust and guardianship of the estate. All three require that the fiduciary be bonded and regularly account in writing to the court.
A litigation special needs trust (Probate Code Sections 3600, 3602(d), (f), 3604, 3611(c)) should be used if the minor must remain eligible for Supplemental Security Income or Medi-Cal or might qualify in the not-too-distant future. The court must approve every compromise involving a minor and payment of money. Probate Code Section 3600. The minor's compromise petition should request that the court make findings under Section 3604, establish the special needs trust and appoint a trustee. The attorney should attach the proposed trust. This avoids delay and unnecessary expense for a separate petition.
The statutory minor's trust is the best choice if eligibility for government assistance is not an issue. Probate Code Sections 3600, 3602(c)(3) and 3611(g). Here again, the proposed trust should be attached to the minor's compromise petition.
The third alternative, a guardianship (Probate Code Sections 1500 to 1601), offers no advantages over the statutory minor's trust. It requires an unnecessary proceeding in the Probate Department, separate from the minor's compromise proceeding.
For adults, there are two primary options: a conservatorship of the estate (Probate Code Sections 1800-1969) or a special needs trust (Probate Code Sections 3600, 3602(d), (f), 3604, 3611(c)). If the injured adult is mentally incompetent, one or the other of these two alternatives must be utilized. A conservatorship of the person may accompany either arrangement where the individual also cannot make decisions regarding personal care.
Somewhat surprisingly, a special needs trust can be established, on a proper showing, for a disabled but mentally competent plaintiff. See Probate Code Section 3603 and 1801(a)(1).
The court can appoint a bank or trust company as the fiduciary, or an individual or individuals can serve in any of the fiduciary roles referred to above; but bond will be required. This bond is similar to that required of the executor of a probate estate.
• How much should be structured? Plaintiffs' lawyers may wonder: How much of the settlement should be structured, and how much should be "up-front" cash? A good rule of thumb is to place half of the net settlement proceeds, plus or minus 10 percent, into a structured settlement, with the balance paid to the fiduciary at once.
Suppose the defense has agreed to spend $750,000 on the settlement, and attorney fees, costs and discharge of liens will require $350,000, leaving a net of $400,000. The recommendation is that $160,000 to $240,000 (i.e., 40 to 60 percent) of the net amount be structured and the remainder paid immediately. Nevertheless, some arrangements have functioned reasonably well for years where all or none the funding is structured payments.
Here are some of the considerations underlying the rule of thumb stated above:
• Usually a certain amount of predictable monthly income is essential for this particular category of potential investors - seriously injured persons.
• Tax-free structured settlement payments are preferable to the inferior yields of various debt instruments and cash equivalents, to which a cautious investor normally devotes 25 to 40 percent of the portfolio. A structured settlement annuity cannot be purchased after the settlement.
• Most individual fiduciaries do not have the time or knowledge to engage in sophisticated investing.
• Caveat: The rule of thumb must be adjusted if a residence is to be bought for the injured party. The house purchase should be all cash. Conventional home mortgages are not available to fiduciaries or disabled persons.
• Caveat: If there is a strong possibility of the plaintiff dying within the ensuing two years, no more than 20 percent of net settlement proceeds should go into the settlement annuity. The problem cannot be cured with a long guarantee period.
• Usually the planning focus is on the injured party's needs, not the expectancies of family successors.
• An age-rated settlement annuity, based on the impaired life expectancy of the injured party, offers unparalleled economic performance. The structure can contain a provision for commutation of guaranteed payments if the annuitant dies early.
• If the present value of the structure exceeds $500,000, it should be divided between two companies; if more than 41 million, among three companies, etc.
• Trap for the unwary. A trap for drafters of special needs trusts exists where a structured settlement has a guaranteed period. The trap results from the statutory requirement that a litigation special needs trust must contain a provision mandating reimbursement to the state, on termination of the trust, in the amount that Medi-Cal has paid for the beneficiary's medical expenses during the operation of the trust. (Distinguish this Medi-Cal reimbursement claim from the Medi-Cal lien, which arises from pre-settlement expenses by Medi-Cal on account of the claim-related injuries.)
The plaintiff and the family desire that, in the event the victim dies before the end of the certain period, the remaining guaranteed payments will flow outside the trust directly to the decedent's estate. But if the trust is given the right to receive all structured payments, then the trustee must receive them; and the Medi-Cal reimbursement claim may reach these dollars.
The correct drafting approach requires a departure from the forms generally used for structured settlements. The drafter should first describe the payment format, omitting mention of the payee, and then describe the payee during the annuitant's lifetime (the trustee). Finally, the drafter should describe the payee for any remaining guaranteed payments due after the annuitant's death is named. (Usually this is the estate.)
One criticism of this approach is that it is unfair to the government. But the drafter has a client, a badly injured individual, and does not work for the government. Moreover, under the rule of Lucas v. Hamm, 56 C. 2d 583 (1961), and its progeny, the estate planner owes a duty to prospective family successors.
Another objection is that a guarantee period shifts settlement value away from the victim because a life-only annuity would pay greater monthly benefits. There is some merit to this second objection, but most people use guarantee periods.
• Valuing the structured settlement. Sometimes probate judges or staff assert that the proper way to value a structured settlement right is to have the present value of that right determined and treated as an estate asset. The better view is that the present value of a structured settlement right is not available to the fiduciary and should not be used in calculating bond or trustee's fees.
A structured settlement annuity is owned by the defendant, its insurer or an assignee of both of them, not by the plaintiff or the estate. The trustee has no right in the annuity; he or she cannot accelerate the payments or sell or encumber the annuity. These arrangements are requisite elements of an income-tax-favored structured settlement. See Internal Revenue Code Sections 104(a)(2), 130; Rev. Rul. 79-220, 1979-2 C.B. 74.
It would be a different case if the estate had purchased an annuity. Then it could be drawn upon, sold or borrowed against; and fluctuations in value would affect the estate. A structured settlement is not an investment by the estate; it is more like a pension right or Social Security. One can learn the present value of a typical pension; but because that value is not available, the information is essentially irrelevant.
• Medi-Cal regulations. Structured settlement funding of a special needs trust must conform to some easily overlooked Medi-Cal regulations. 22 C.C.R. Section 50489 et seq. Annuity payments must be "immediate," defined as starting within one year of settlement. The annuity must provide "level" income, but this is given a practical twist: Payments can increase by up to 5 percent per year. The guarantee period cannot exceed life expectancy, and the life-expectancy figure must be that actually used by the annuity company.
William L. Winslow is an attorney at Farmer & Ridley in Los Angeles.
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