A personal injury trust is a trust set up by, or on behalf of, someone in receipt of compensation monies for an injury sustained by them. Personal injury trusts have major benefits for injured persons and their families: they can be used to protect assets from being wasted or misused and they can also preserve the injured person’s entitlement to certain state benefits.
A personal injury trust is special by virtue only of how it is funded - any type of trust can be used to create a personal injury trust. There are several different possible kinds of trust but choosing the right one, in any given situation, is a matter for careful consideration, particularly when it comes to inheritance tax.
Bare trust
A bare trust is the most common type of personal injury trust. The beneficiary is entitled to receive the trust property at any time. This is a sensible option where there is no asset protection consideration, and the purpose of the trust is only to conserve entitlement to means-tested benefits. That said, if there is a serious concern that the beneficiary may squander the funds to their detriment, then a bare trust is not appropriate.
A bare trust is tax-neutral so, on the injured person's death, the fund is part of their estate and subject to inheritance tax (IHT) in the usual way. The capital and income of the trust is also treated as belonging to the injured party.
Liferent trust
A liferent trust gives the injured person a right to the trust income. The injured party is not automatically entitled to the capital of the fund but normally, the trustees can make additional payments to them. A liferent trust is useful in cases where a more protective structure is needed but, for injured persons who are unlikely to waste the funds, it may be unnecessary, more expensive to operate, and unduly restrictive.
Unless the trust falls within the disabled persons' trust criteria (more on that below) there will be an IHT on funds in excess of the nil rate band (currently £325,000) on creation of the fund (an entry charge) as well as when capital is paid to the injured person (an exit charge). The trust will also be subject to IHT 10 yearly charges.
This option should be used with caution and careful consideration needs to be given to whether the disabled trust criteria are met before settling a significant sum (over £325,000) if an immediate charge to IHT is to be avoided.
Discretionary Trust
A discretionary trust has a set class of potential beneficiaries - the injured party cannot be the sole beneficiary. The responsibility of determining who should benefit within the class lies with the trustees. They must choose, at their discretion, who the trust fund will benefit, when and in what proportion.
For IHT purposes the position is the same as for a liferent trust with possible entry charges, 10-year charges and exit charges. Again, these will be avoided if the trust qualifies as a disabled persons' trust.
Disabled persons' trusts
Special IHT treatment is conferred on discretionary and liferent trusts that qualify as disabled persons' trust. They are not subject to any entry, ten-year, or exit charges.
For tax purposes, a disabled person is someone who is incapable of managing their property or affairs due to a mental disorder; or who receives or would be entitled to receive a range of state benefits including Personal Independence Payment or Disability Living Allowance (with the care component at the middle or highest rate, or mobility component at the higher rate).
Like on the death of a beneficiary of a bare trust, the value of the trust fund at the date of death will form part of the injured person’s estate for IHT purposes.
Beware!
Transferring a significant award into trust can have serious and immediate inheritance tax implications. Seeking expert advice is crucial. Failure to do so can result in adverse financial consequences. Choosing the right type of trust is essential to ensure the award is protected both now and in the future.
If you think that you or your client would benefit from a discussion about personal injury trusts, please get in touch.
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