Settlement Trusts + Structured Settlements = Settlement Planning?
Once considered a competitive product, most structured settlement professionals and settlement planners now view settlement trusts as an essential and complementary part of their personal injury settlement solutions.Trusts, which are legal entities and can be revocable or irrevocable, can have many purposes including wealth accumulation, spendthrift protection, avoidance of probate, and reduction of taxes. Trusts that are used in connection with personal injury settlements are referred to as settlement trusts.
Similar to structured settlement annuities, the purposes of settlement trusts include: preventing the claimant/beneficiary from squandering settlement proceeds; ensuring settlement proceeds are used for their intended purposes; and providing funds in amounts and at times when needed. Settlement trusts may be utilized as an alternative to structured settlements or in conjunction with structured settlement annuities to address settlement planning objectives and issues or to preserve or maximize government benefits such as Medicare, SSI and Medicaid.
Several types of settlement trusts exist including:
- Qualified Government Bond Trust
- Reversionary Grantor Trust
- Settlement Preservation Trust
- Special Needs Trust
- IRC 468B Qualified Settlement Fund
All trustees are fiduciaries, which obligates them to act in the “best interest” of the trust beneficiary(s). A fiduciary duty requires a high standard of honesty and full disclosure including any potential conflicts of interests. A fiduciary must not obtain a personal benefit at the expense of his or her client. Regardless of who sells or provides a financial or insurance product to a settlement trust, and what independent duties that product provider might have to a trust beneficiary (i.e. injury victim), a settlement trustee’s own fiduciary duties arguably should require a settlement trustee to evaluate specific trust products, trust product providers and their related business conduct utilizing that same fiduciary standard which requires honesty, full disclosure, and best interest.
Uniform Prudent Investor Act
In addition to the trust document itself, and the trustee’s fiduciary duty, the Uniform Prudent Investor Act (UPIA) serves as an important legal reference defining a settlement trustee’s duties of care and responsibilities for investments in states where it has been enacted. The UPIA, which was adopted by the National Conference of Commissioners on Uniform State Laws in 1994, has been enacted, with some state-specific modifications, by 44 states and the District of Columbia.
Prior to the UPIA, courts applied the “prudent man rule“ when evaluating trustee investment performance. The UPIA, by contrast, adopts ”modern portfolio theory” as a different and more appropriate standard for trustees. Compared with the prudent man rule, modern portfolio theory promotes a holistic view of trust assets by focusing on the total return generated by a trust as opposed to viewing a trust’s income and principal separately. This newer standard allows for greater investment diversification so long as the risk/reward ratio matches the purposes and terms of the trust document.
To demonstrate prudence and good faith and thereby fulfill his or her fiduciary duties, the UPIA establishes a number of investment duties for trustees including:
- duty to have an investment strategy.
- duty to monitor risk/return.
- duty to diversity.
- duty to pay only fair fees.
- duty to prudently delegate.
- duty to monitor an agent’s activities.
Section 2(c) of the UPIA identifies eight factors a trustee should consider when making any investment:
- General economic conditions
- The possible effect of inflation or deflation
- The expected tax consequences of investment decisions or strategies
- The role that each investment or course of action plays within the overall trust portfolio
- The expected total return from income and appreciation of capital
- Other resources of the beneficiaries
- Needs for liquidity, regularity of income, and preservation or appreciation of capital
- An asset’s relationship of special value, if any, to the purposes of the trust or to one or more of the beneficiaries
When settlement trusts play a role in a personal injury settlement, structured settlement and settlement planning professionals should be prepared to address these factors as part of their sales strategy. Significant for structured settlements, the UPIA’s list of investment considerations fails to mention mental or physical disabilities of a trust beneficiary. From a settlement planning perspective, injuries or diseases that create special needs or reduce an individual’s normal life expectancy arguably should receive important consideration when a trustee makes investment decisions.
For additional information about settlement trusts and other structured settlement financing alternatives, see Chapter 3 of “Structured Settlements and Periodic Payment Judgments”.