There are a number of reasons why an individual may decide to settle assets in trust and one of the most prominent is to protect family wealth and look after the long-term interests of family members. Protection of family interests becomes a more relevant factor where a family member is in some way vulnerable. Where a beneficiary is classed as vulnerable in terms of the applicable law, preferential tax treatment can be applied to a trust.
What constitutes a Trust for a Vulnerable Person?
There are two categories of trust which can be categorised as trusts for vulnerable people:-
i) Trusts for Bereaved Minors
This type of trust will usually arise where a parent leaves a Will that makes trust provisions for a child under the age of 18 (such trusts can also arise by variation on intestacy). The terms of the trust are that the income and capital in the trust is paid to the child by the age of 18. The trust benefits from certain tax advantages not available to a standard discretionary trust arrangement while the child is under 18.
ii) Trusts for Disabled Persons
This is a type of trust which has the character of a discretionary trust, but benefits from preferential tax treatment arises, because the trust is either an interest in possession trust for a disabled person or is deemed to be one. The trust fund must be applied almost exclusively for the benefit of a disabled person.
The trust must qualify but so too must the beneficiary. A disabled person in this context is someone who either (i) cannot manage their own affairs because of a mental health condition covered by the Mental Health Act 1983 or (ii) is entitled to receive one of the following benefits:-
- Attendance Allowance
- Disability Living Allowance (either the care component at the highest or middle rate, or the mobility component at the higher rate)
- Personal Independence Payment
- An increased disablement pension
- Constant Attendance Allowance
- Armed Forces Independence Payment
For trusts that came into existence after 17th July 2013, the favourable tax treatment will apply if no more than £3,000 or 3% (whichever is less) of the trust fund is applied for someone other than the disabled person.
What are the benefits?
Depending on the value of the settlement, transfers to a discretionary trust can be subject to inheritance tax charges on the date of transfer, on every 10-year anniversary and when assets exit the trust. This taxation regime does not, however, apply to trusts for vulnerable people. Instead, if the beneficiary dies, any assets held in the trust on their behalf are treated as part of their estate.
The trustees are also entitled to preferential income tax and CGT treatment compared to that of trustees of a standard discretionary trust. It is, however, worth noting that the process for obtaining that preferential tax treatment can be administratively onerous and there are specific rules which apply to self-settled trusts.
When to consider using settling a trust?
The appropriateness of settling trust for a vulnerable family member will ultimately depend on circumstances. It is important to remember that the trust fund will be treated as part of the beneficiary’s estate on death and may not – overall – be the most efficient option. In addition, the rules as they relate to benefiting people other than disabled person are very restrictive. However, where someone is disabled in terms of the legislation and is due to inherit a substantial sum, a trust may be appropriate where there are concerns about long term management of that inheritance.