The use of trusts for vulnerable beneficiaries

Types of trusts for vulnerable beneficiaries

Trust arrangements provide a protective framework from which vulnerable beneficiaries can benefit by being within the class of potential beneficiaries. The funds within the trust are held by the trustees, meaning that the vulnerable beneficiary would not be involved with the management of the money themselves. There are three key trust structures available:

1. A discretionary trust
2. A life interest trust
3. A vulnerable beneficiary trust.

The Trustees

In any trust, the choice of trustees is very important. Wide powers are conferred on them and so it is vital to ensure that they can be trusted to safeguard the trust assets and always to act in the best interests of the beneficiaries. It is desirable for the person creating the trust (the Settlor) to write a letter of wishes providing the trustees with non-binding guidance as to how the Settlor would want them to act. In some circumstances, it may also be desirable to appoint one or more professional or other independent trustees.

Discretionary Trusts

Discretionary trusts provide the trustees with a huge amount of flexibility, giving them full discretion over how the capital and income within the trust can be used for the benefit of the chosen class of beneficiaries. With discretionary trusts, there is a named class of potential beneficiaries, allowing the trustees to exercise their discretion as to who should benefit, by how much and when. This allows the trustees to take into account the vulnerable beneficiary’s circumstances.

As the assets are managed and held by the trustees, the assets within the trust do not aggregate with the vulnerable beneficiary’s assets for the purposes of means tested benefits. This means the trustees can exercise their discretion to transfer capital and/or income to the vulnerable beneficiary as and when it is appropriate to do so, taking into account any changing needs or requirements the vulnerable beneficiary may have.

The tax regime and advice regarding the management of discretionary trusts falls outside the scope of this information sheet, but bespoke advice can be provided if requested.

Life Interest Trusts

With a life interest trust, the income is mandated to the life tenant who could be the vulnerable beneficiary, with the capital held at the discretion of the trustees. This means the vulnerable beneficiary would receive all of the income generated by the trust, together with having the right to the present enjoyment of the assets comprised within the trust (for example, to live in a property owned by the trust). This structure can often provide comfort knowing the vulnerable beneficiary is going to receive the income and is not at the mercy of the trustees exercising their discretion in order to benefit.

The capital is held at the discretion of the trustees, allowing others to be able to benefit during the life tenant’s lifetime. The downside with this trust structure is, if the capital assets are significant, the income received could again affect the vulnerable beneficiary’s entitlement to means tested benefits.

In addition, there are tax consequences to consider if capital is paid out of the trust during the vulnerable beneficiary’s lifetime. Again, the tax consequences of this and the trust structure more generally fall outside of the scope of this information sheet, although advice can be provided separately.

Vulnerable Beneficiary Trusts

A vulnerable beneficiary trust operates broadly similarly to a discretionary trust, giving the trustees discretion to decide what, if any, benefits should be given to any of the beneficiaries and at what times. However, the tax treatment is significantly different to a discretionary trust (see below) and the use of these trusts is limited to situations where the primary beneficiary of the trust is deemed to be “disabled”.

Who qualifies as a disabled beneficiary?

A disabled beneficiary is a person who by reason of mental disorder as defined under the Mental Health Act 1983 is incapable of administering their property or managing their affairs, or a person who is in receipt of social security benefits relating to disability. The relevant social security benefits are:

• Attendance allowance
• Disability living allowance for adults or children (but the person must be entitled to the care component at the highest or middle rate or the mobility component at the higher rate)
• Personal independence payment
• Increased disablement pension
• Child Disability Payment
• Adult Disability Payment
• Industrial Injuries Disablement Benefit
• Constant attendance allowance
• Armed forces independence payment.

Requirements to qualify as a Vulnerable Beneficiary Trust

In addition to the beneficiary meeting the criteria above, the trust itself must 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 the trust income, or, if the trustees have discretion as to if and when the income is paid out, then any income payments must be for the benefit of the disabled person during their lifetime.

Although other people can be named as potential beneficiaries, the trustees are limited to how much the other beneficiaries can receive, currently being the lower of £3,000 per tax year or 3% of the maximum value of the trust fund.

Provided these conditions are met, the trust will be treated more favourably than other types of trust in respect of Income tax, Capital Gains Tax and Inheritance Tax.

Tax implications of a Vulnerable Beneficiary Trust

Inheritance Tax (IHT)

Most trusts are liable to pay IHT on creation, every ten years and whenever assets leave the trust. Vulnerable beneficiary trusts are not subject to these charges.
However, the value of the trust will aggregate with the disabled person’s own assets for IHT purposes on their death, whereas a discretionary trust would not. If the trust is set up by will, IHT will potentially be payable on the testator’s death , and again on the vulnerable beneficiary’s death if the combined value of the trust and their own assets is over the available nil rate band at the time.

Capital Gains Tax (CGT)

CGT is payable if there is a disposal of assets in the trust (that is, assets are sold, given away, exchanged or transferred in another way and they have gone up in value since entering being acquired). CGT is payable by the trustees, and is only due if the assets have increased in value above the ‘annual exempt amount’ (currently £3,000). For most trusts, only half of this exemption is available. However, vulnerable beneficiary trusts are taxed as if the disposal was made by the vulnerable beneficiary and therefore the full £3,000 annual allowance is available.

Income Tax

Discretionary trusts normally pay income tax at the rate of 45%. However, vulnerable beneficiary trusts are taxed as if the income belonged to the vulnerable beneficiary. This allows the trust to take into account the beneficiary’s personal allowances and means that income tax will likely be charged at the vulnerable beneficiary’s marginal rate of tax.

To be able to claim special tax treatment for income and capital gains tax purposes, the trustees must make a Vulnerable Person Election, no later than 12 months after 31 January following the tax year when they want the election to start. Any income or gains before the date the election takes effect are taxed under normal trust rules.
The trustees must also inform HMRC if the beneficiary stops being a vulnerable beneficiary, or dies.

Administration

All trusts need to be properly administered. This usually involves the trustees registering the trust with HMRC’s online Trust Registration Service, filing annual Tax Returns and issuing appropriate tax deduction certificates to beneficiaries who have received income. If the trust qualifies as a disabled person’s trust it may be exempt from registration with the Trust Registration Service, but the trust will need to register if it has a tax liability in any tax year. The trustees should also maintain trust accounts and properly manage the trust’s property or investments. The amount of administrative work will depend on the nature of the trust assets and on the frequency of any distributions of income and capital.

Each vulnerable beneficiary’s circumstances will be different, and bespoke advice should be sought in each case as there is no one size fits all approach for deciding which trust structure is best suited to a particular beneficiary.

If you require further information, please contact Neha Iqbal or Simon Mitchell.