How to make provision for vulnerable beneficiaries

Often clients are faced with a difficult decision about how to structure their estate (including their will) when they are leaving a gift to a vulnerable beneficiary, such as a child who has a disability or difficulties managing their own finances.  For the purpose of this article, the beneficiary is referred to as the vulnerable beneficiary.

It is key when leaving assets to vulnerable beneficiaries that care is taken to ensure your estate upon your death is structured in such a way that they can benefit from the money you intend to leave them but in a safe and appropriate way. There are a number of options available, as follows.

What are outright gifts?

People often leave a cash legacy under the terms of their will, be that to family members, friends or charities. This is often a token by you to them for them to use the money as they wish. However, the problem with a vulnerable beneficiary receiving a cash legacy is that it may leave them in a more vulnerable position than they would have been otherwise. For example, the beneficiary could potentially be exploited by others seeking to take advantage of the money they have received.

It is also worth bearing in mind that any outright gift (be that through a cash legacy or a gift of a share of your residuary estate) could have an adverse impact upon their entitlement to any means-tested benefits, thus reducing the amount they are entitled to receive from those benefits or perhaps removing their entitlement altogether. Therefore, often it is advisable not to leave outright gifts to vulnerable beneficiaries, instead leaving assets into a trust structure from which the beneficiaries can benefit.

How do Trusts work?

Trust arrangements are often incorporated into someone’s will to provide a protective framework from which vulnerable beneficiaries can benefit by being within the class of potential beneficiaries.  The difference between a trust as opposed to an outright gift is that 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 (which removes the concerns set out above about others seeking to take potential advantage of the beneficiary’s vulnerability).  There are three key trust structures to consider:-

1. Discretionary trusts;
2. Disabled persons’ trusts; and
3. Life interest trust.

What about Discretionary trusts?

Discretionary trusts provide for ultimate flexibility, leaving the trustees (chosen by you and appointed in your will) to have full discretion over the capital and income within the trust together with who should benefit. With discretionary trusts, there is a class of potential beneficiaries named, leaving the trustees being able to exercise their discretion as to who should benefit, by how much and when, therefore allowing them to take into account the vulnerable beneficiary’s circumstances.

Because the assets are managed and held by the trustees, the assets within the trust do not aggregate with the vulnerable beneficiary’s estate for the purposes of means tested benefits. It therefore means the trustees can exercise their discretion to pass over capital and 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 article, but bespoke advice can be provided if requested.

How does a Disabled Person’s Trust work?

A disabled person’s trust operates broadly similarly to a discretionary trust, whereby again the trustees have flexibility as to how the income and capital of the trust is managed, for whom and by how much.  However, the tax treatment is significantly different to a discretionary trust (and, again, the tax regime applicable falls outside the scope of this article).

There are, however, some limitations in that the primary beneficiary of the trust must be deemed to be “disabled” which can either mean  being in receipt of one of a set list of state benefits or being incapable of managing their affairs by reason of a mental disorder as defined under the Mental Health Act 1983. The downside with this structure is that, although other beneficiaries can be listed as a potential beneficiary of the trust, the trustees are limited as 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.

The upside with this structure is that it can be set up during your lifetime, without an entry charge for Inheritance Tax (IHT) applying (as would otherwise be the case for discretionary trusts set up during someone’s lifetime), although the downside with this structure is the value of the trust will aggregate with the disabled person’s own estate for IHT purposes on their death, whereas a discretionary trust would not.  If the value of the trust is significant, it could see IHT potentially being paid on your death before the trust is created, 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.

Because of the lack of flexibility of others being able to benefit and the inheritance tax treatment on the disabled person’s death, it can often be preferential for these reasons to opt for a fully discretionary trust.

How does a life interest trust work?

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.  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.

However, again, the capital is held at the discretion of the trustees, allowing others to be able to benefit during the life tenant’s lifetime (see below). 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 be borne in mind if capital is advanced from the trust during the vulnerable beneficiary’s lifetime. Again, the tax consequences of this and the trust structure more generally falls outside of the scope of the article, although advice can be provided separately.

How do you know what provisions to make for vulnerable beneficiaries?

Each vulnerable beneficiary’s circumstances are different, and bespoke advice should be sought regarding your Will structure, depending on the beneficiary’s circumstances. There is no one-size fits all approach in deciding which trust structure is better than the other.

If you would like any further information about vulnerable beneficiaries and the appropriate structure please contact Amy Lane on 01892 701366 or amy.lane@ts-p.co.uk.