A trust is a legal mechanism to hold assets for someone. The settlor (i.e. you) creates a trust by giving property a trust fund. The settlor chooses trustees who then hold the trust property (along with any income from it) on behalf of one or more beneficiaries. The trustees have discretion to decide how the trust assets should be used to benefit the beneficiaries.
Trusts can be set up for many reasons, but are particularly useful for people who need looking after and might not be able to manage their finances themselves. Specific trusts are available for disabled persons and such trusts are flexible as they are able to adapt to the beneficiary’s changing circumstances and any future needs that might arise. The trust can be created during your lifetime or through your Will so that it takes effect on your death.
A Disabled Persons trust must have a disabled person as the primary beneficiary, but there should also be other beneficiaries named (such as other children or family members). The Trustees have a lot of flexibility and discretion as they will decide which beneficiaries will benefit from the trust fund and to what extent. As the trust is discretionary, the beneficiaries do not have an absolute right to the trust fund, only the potential to benefit from it. This is particularly helpful as it means that the trust fund is not taken into account if the beneficiaries are in receipt of means tested benefits.
All trusts are subject to tax, be it capital gains tax, income tax or inheritance tax. However, when the beneficiary is disabled, the trust may be eligible for special tax treatment. There are various conditions that must be satisfied, but ultimately, the aim is to reduce the tax payable by the trust so that funds are preserved for the benefit of the disabled person.
Defining a ‘Disabled Person’
To set up this type of trust, the beneficiary must be a disabled person. For this purpose a disabled person is defined as one of the following:
- By reason of ‘mental disorder’ within the meaning of the Mental Health Act 1983, someone who is incapable of administering his property or managing his affairs. HMRC accept the following conditions as a ‘mental disorder’:
- Alzheimer’s or other forms of dementia;
- Bipolar disorder, schizophrenia, depression or other mental illness;
- Autistic Spectrum Disorder;
- Learning disability, e.g. Down’s syndrome
- Brain injuries and Parkinson’s Disease, but only when they cause psychological, cognitive or behavioural disorders
- A person who qualifies under a ‘benefits test’ in that they are eligible for any of the following benefits (even if they don’t receive them):
- Personal Independence Allowance
- a disablement pension
- Constant Attendance Allowance
- Armed Forces Independence Payment
Special tax treatment
Conditions that need to be met
The beneficiary must meet the above definition of ‘disabled’. In addition, the trust itself needs to be a “qualifying trust”. This means that there must be certain restrictions on who can receive benefits from the trust during the disabled person’s lifetime. These are as follows:
- any capital leaving the trust must be used for the benefit of the disabled person
- the disabled person must either be entitled to all of the income outright, or, if the Trustees have the discretion as to if and when the income is paid out, then any payments made must be used to benefit the disabled person during their lifetime.
Once these conditions have been met, then then the trust will be treated more favourably than normal trusts in respect of Income tax, Capital Gains Tax and Inheritance Tax.
The trustees can make an election so that tax on income within the trust will be charged as if it had accrued directly to the vulnerable beneficiary. This enables the trust to take into account the beneficiary’s personal allowances and means that Income tax would likely be charged at a marginal rate, rather than the normal trust rate tax of up to 45%. To gain this special treatment, the Disabled person must be entitled to all income arising during their life (or, alternatively no income can be applied during life of disabled person for benefit of anyone else).
Capital Gains Tax
Capital Gains Tax may be due if assets are sold, given away, exchanged or transferred in another way and they’ve gone up in value since being put into trust. Tax is only paid by trustees if the assets have increased in value above the ‘annual exempt amount’. For normal trusts, this exemption is £5,650; for Disabled person’s trusts, this allowance is doubled to £11,300. Any gain above this amount is taxed at 20%. The trustees are responsible for paying any Capital Gains Tax due.
Most trusts are liable to pay Inheritance tax every ten years (an ‘anniversary charge’) and when assets leave the trust (an ‘exit charge’). Disabled trusts are not subject to these charges. On the death of the disabled person, the trust property is treated as being owned by them. If the disabled person’s estate exceeds £325,000, there will be an Inheritance tax charge of 40% on anything over and above this amount.
You, as the settlor, could be liable to pay Inheritance tax. If the trust is set up in your will, any inheritance tax due on your estate will be paid as normal before the trust is created. (This would be the case irrespective of how your Will distributes your assets). If you set the Trust up during your lifetime (as opposed to through your Will), there could be a charge to Inheritance tax if you do not survive the gift by 7 years.
Frequently Asked Questions
How do I set up a Disabled Persons Trust?
- You can set up the Trust during your lifetime or, alternatively, the trust can be set up in your Will. Williamsons Solicitors can assist you and prepare the necessary documentation.
Why should I put my assets into a trust?
- A Disabled Person’s Trust can be a way of ring-fencing assets for the beneficiary so that their means-tested benefits are not affected.
- A Trust can protect a disabled person who could otherwise be vulnerable to financial abuse or exploitation from others.
- The Trust offers a means of managing money or other assets for a disabled person, which is invaluable if they are unable to do this themselves.
- Such a Trust can safeguard the Disabled person’s future security
Are there any disadvantages to setting up a Trust?
- Trustees have discretionary powers over Trust assets, including if, how and when they should be distributed. The disabled person does not have an absolute right to those assets. Whilst this could be seen as a disadvantage of setting up a Trust, the advantages stated above may outweigh this.
What happens when the disabled person dies?
- If the trust is part of your Will, then on the death of the disabled person, the trust will end and the trustees will distribute the remaining trust funds (if any) according to the terms of the Will.
What happens if I don’t set up a Trust?
- If you do not make any provision for a Disabled person, there is no legally binding way of ensuring that they are financially provided for.
- Relying on a family member to look after your child could be risky as they could change their minds or their own circumstances could change meaning that they can no longer look after your child.
- If your Will does not make adequate provision for a disabled person, then it could be challenged. This can result in costly legal action.
- If you leave assets directly to your intended beneficiary (on the basis that they would set up the trust themselves) it could create difficulties for them, especially if they are receiving means-tested benefits.
Please note that this is intended as general advice. It should not be relied upon as specific legal advice. If you require further information about Disabled Person’s Trusts, please do not hesitate to contact Williamsons Solicitors on 01482 323697 and ask to speak to a member of our Wills & Probate department.W