Does Settlement Money Affect FAFSA?
While many states have extended financial aid deadlines in light of COVID-19, parents of injured children should remain proactive when it comes to college planning. Settlement funds, which families must report on the Free Application for Federal Student Aid (FAFSA), may compromise financial aid eligibility. Fortunately, there is a tax-advantaged strategy to preserve settlement funds and financial aid eligibility.
Structured Settlements for Minors
Courts want to ensure that minors’ settlement funds will withstand financial crises. Most states will not allow cash settlements for minors, recognizing the many risks involved. Instead, courts prefer the use of structured settlements, minors’ trusts, or guardianship accounts. Each of these options can be set up to pay out the settlement funds once the minor reaches the age of majority, which varies by state.
However, if the minor plans to attend college, the escalating costs of tuition, room, board, books, supplies, activity fees, and more could quickly eat up the settlement funds.
Rather than beginning payments at age 18 or earlier, structured settlement payments can be arranged to begin paying out after the anticipated graduation date.
Structured settlements offer many benefits, including:
- Allowing the settlement funds to be uncountable when determining financial aid eligibility (assuming the structured settlement payments are arranged to begin post-college);
- Guaranteed1, income tax-free payments, backed by highly capitalized insurance companies with long track records of positive performance;
- Income tax-free growth; and
- Flexible plan design (for instance, structured settlement payments can supplement post-college income or provide a nest egg for more considerable expenses, such as a home purchase).
Settlement Options for Disabled Minors
If your client is a disabled minor, s/he may be eligible for a special needs trust. Money held within a special needs trust does not count towards assets, so it will not impact financial aid. If a structured settlement is used to fund the special needs trust, the minor can take advantage of income tax-free growth and an extra layer of financial protection.
If the disability occurred before age 26, an ABLE Account may also be a viable option. However, unlike special needs trusts, ABLE Accounts do have an annual contribution threshold and lifetime contribution thresholds that vary by state. ABLE Account funds must remain under the appropriate thresholds for a beneficiary to remain exempt from asset tests.
Contact Sage with Your Next Minor’s Case
1 Guarantees are subject to the claims-paying abilities of the issuing insurance company.