Quick guide to Disabled Persons’ Trusts
In certain circumstances, a trust may qualify as a ‘disabled persons’ trust’ under the inheritance tax legislation and as a ‘vulnerable person trust’ under income tax and capital gains tax legislation, giving rise to potentially more favourable tax treatments. This article refers to both types of trust as disabled persons’ trusts.
Who qualifies as a disabled person for the purposes of the legislation?
A person is ‘disabled’ for tax purposes if they:
- are incapable of administering or managing his/her property or affairs because of mental disorder within the meaning of the Mental Health Act 1983; and/or
- are in receipt of any of the following: attendance allowance, disability living allowance (DLA) based on entitlement to the care component at either the middle or highest rate or the mobility component at the higher rate, personal independent payment (PIP), an increased disablement pension, constant attendance allowance and/or armed forces independence.
Can someone settle a disabled persons’ trust for themselves?
Yes. It is possible for an individual to settle assets into trust for their own benefit provided that at the time the property is settled, the individual is reasonably expected to, at some stage in the future, qualify as a ‘disabled person’ under the legislation.
This is particularly helpful for people who, for example, have been diagnosed with a degenerative disease such as MS or Parkinson’s or who suffer from certain types of mental illness which mean that at times they are incapable of managing their own affairs.
What are the tax benefits of a qualifying trust?
A gift into trust ordinarily amounts to a lifetime chargeable transfer which can give rise to an immediate IHT charge on entry at the rate of 20%. In addition, lifetime trusts are subject to the relevant property regime of taxation which imposes IHT charges (1) on each 10 year anniversary of the trust and (2) when capital distributions are made to beneficiaries. These charges are calculated by reference to the value of the trust fund and can be burdensome and costly.
In addition, trustees of lifetime trusts generally pay income tax and capital gains tax at the highest rates. They do not benefit from a personal allowance and they only have a reduced annual exempt amount for CGT purposes (being ½ of the amount available to individuals).
A gift into a disabled person’s trust however does not amount to a lifetime chargeable transfer, but rather is a potentially exempt transfer (‘PET’). Provided the settlor survives the gift by 7 years, the value will fall out of account for IHT purposes in the settlor’s estate. The value in the trust is not subject to the relevant property regime but rather is deemed to belong to the disabled beneficiary for tax purposes such that, on the beneficiary’s death, the value is aggregated with their own free estate and taxed accordingly.
It is also possible for the trustees to make a ‘vulnerable person’s election’ such that tax on the income and gains of the trust will be no greater than if the income and gains had arisen directly to the vulnerable beneficiary.
How flexible is a disabled person’s trust?
A disabled person’s trust can be very flexible. It need not give the beneficiary a life interest in the trust’s assets but can give the trustees complete discretion over both income and capital if desired.
An important point to note however is that in order to qualify for the favourable tax treatment outlined above, the funds must be applied almost exclusively for the benefit of the disabled beneficiary. There is a express prohibition on payments of the lower of £3,000 or 3% of the value of the trust fund being made to non-vulnerable beneficiaries in any given tax year.
Is a disabled person’s trust better than a non-qualifying discretionary trust?
Not necessarily. There are advantages and disadvantages of both types of trusts depending on the specific circumstances of the beneficiary, the intended aims of the settlor and the tax position.
For example, whilst it may be beneficial to be able to settle an unlimited amount of value into a disabled persons’ trust without giving rise to an immediate IHT charge, holdover relief for CGT purposes is generally not available in these circumstances unless business assets are settled.
Care therefore needs to be taken to ensure that the trust is tailored to the specific wishes and needs of the settlor and the beneficiary and professional advice should be sought.