Disabled Persons Trust

For those wishing to make provision for those suffering from a mental or severe physical disability, whether that be themselves or another person, may wish to look at the possibility of creating a Disabled Persons Trust.

There is the option of making provision for a disabled person in lifetime and/or through a Will. As a consequence of the Finance Act 2006 substantial changes took place regarding trusts. The majority of trusts now all have the same tax regime but those which benefit a disabled person are an exception to the rule and may attract favourable tax treatment. Therefore any trust which is established could take advantage of the inheritance tax, income tax and capital gains tax relief available if the trust meets certain prescribed conditions. This section deals with planning that can be undertaken in lifetime.

Definition Of A Disabled Person Trust

A disabled person means a person who is:

  • by reason of mental disorder, within the meaning of the Mental Health Act 1983, incapable of administering their own property or managing their own affairs; or
  • in receipt of Attendance Allowance under section 64 Social Security Contributions and Benefits Act 1992; or
  • in receipt of Disability Living Allowance  under s71 Social Security Contributions and Benefits Act 1992 by virtue of entitlement to the care component at the highest or middle rate.

Attendance Allowance is a benefit payable to those who are aged 65 or over and are not entitled to the care component of Disability Living Allowance and are so severely disabled that they require from another person frequent attention during the day and continual supervision throughout the night as they may be a danger to themselves or to others.

Disability Living Allowance at the middle or higher rate is paid to those who are so disabled that they are unable to prepare a meal for themselves, require frequent assistance throughout the day, especially regarding bodily functions and require continual supervision throughout the day and night as they may be a danger to themselves or to others.

Types Of Trust

Legislation now allows that trusts can be created by a third party for a disabled beneficiary or by a disabled person to benefit themselves. The key principle is that the person who is to be the principal beneficiary must be a disabled person at the time the trust is established. This is included to mean those who are establishing the trust for their own benefit and who have a condition that it is reasonable to expect at the date of the trust will lead to the person satisfying the criteria of a disabled person.

There are two main types of trust available:

  • Non interest in possession trust
  • Interest in possession trust

Non Interest In Possession Trust

This is a discretionary trust arrangement where the disabled person has no interest in possession. This means that there is no right for the disabled person to receive the income from the trust. In these types of trust at least 50% of the capital of the trust must be applied for the benefit of the disabled person during their lifetime.

The income can be held on unrestricted discretionary trusts throughout the lifetime of the disabled person. Whilst in the majority of cases both the income and the capital will be preserved in the trust or applied for the benefit of the disabled person, there may be circumstances where it would be desirable to appoint up to half of the capital to, or for the benefit of, other beneficiaries.

For inheritance tax purposes, the disabled person would be treated as having an interest in possession which means that the value of the trust would be treated as forming part of the estate of the disabled person on their death. A lifetime transfer into this type of trust would be a potentially exempt transfer and therefore the Settlor (the person creating the trust) would need to survive for a period of seven years to avoid the value of the transfer being aggregated with their own estate on death.

This is also the same position if an advancement is made out of the trust to a beneficiary who is not the disabled person – the disabled person is treated as having made a gift of the sum from the trust and it is classed as a potentially exempt transfer.

This type of arrangement would not affect means tested benefits as it does allow for income to be accumulated. However, generally, payment of income will be treated as income for means-tested benefit purposes and are likely to affect such benefits.

Interest In Possession Trust

These types of trusts confer an interest in possession directly to the disabled person. As a result, the disabled person becomes the life tenant of the trust with an absolute right to the income. Unlike the non interest in possession above, there are no restrictions as to the capital of the trust. It may be applied for the benefit of the disabled person if required.

For inheritance tax purposes the trust property will belong to the disabled person’s estate upon death. A lifetime transfer into such a trust will once again be a potentially exempt transfer therefore avoiding any of the restrictive tax regime introduced by the Finance Act 2006.

All income paid under this arrangement will be taken into consideration for any means tested benefits to which the disabled person may be entitled.

Capital Gains Tax & Inheritance Tax Reliefs

A disabled person trust may also have other taxable benefits.

Capital Gains Tax - The trust may have a full capital gains tax allowance as opposed to the half allowance which is normally available to trusts. To qualify for this the trust must secure that the disabled person must be entitled to at least half of the income of the trust or there needs to be a right that no other beneficiary can receive the income.

Vulnerable Beneficiary Election - The trustees and the disabled person could make an irrevocable vulnerable person election and then the trustees could make an annual claim for a tax rebate. The effect of this election would be that the trustees would pay tax at the rate applicable if the income had arisen directly to the disabled person. For income tax purposes the trustees would pay the same rate of tax as the disabled person would have paid. Once again, the qualifying criteria are strict and it may be necessary to ring fence trust assets to which it may apply.

Is There Another Option?

There is the option of setting up a discretionary trust in lifetime which does not have any of the tax benefits described above and will attract ten yearly charges and exit charges for inheritance tax purposes. This type of arrangement can benefit a disabled person but also other children, family members etc with no restrictions as to the income and capital to be applied for the benefit of the disabled person.

If capital is released to the disabled person then this will affect benefits payable. Items can be bought from the trust for the benefit of the disabled person (not for resale) but these have to be reasonable to not affect the benefits. What is reasonable is open to interpretation. If the trust fund is likely to be below the threshold for inheritance tax (currently £325,000) this may be a more favourable option to take.

Further Opportunities

Where a lifetime gift into a trust is being considered and there is a concern that the donor (the person making the gift) may not survive the necessary seven year period for inheritance tax purposes consideration should be given to the availability of dependent relative relief to exempt the gift from inheritance tax.

Greg Baker
Partner, Head of the Wills, Trusts and Probate Department
01733 295616
Probate and Estate Administration, Wills, Trusts & Wealth Management
Jo Wild
Associate Solicitor
01780 750952
Probate and Estate Administration, Wills, Trusts & Wealth Management
Andrea Beesley-Hewitt
Associate Solicitor
01733 295552
Probate and Estate Administration, Wills, Trusts & Wealth Management
Emma Carter
01733 295608
Probate and Estate Administration, Wills, Trusts & Wealth Management
Claire Clarke
01572 725774
Probate and Estate Administration, Wills, Trusts & Wealth Management
Diane Baker
Probate Assistant
01733 295663
Probate and Estate Administration, Wills, Trusts & Wealth Management