Disabled person’s trust or discretionary trust – which is best?
How to choose between a disabled person’s trust and a discretionary trust
A discretionary trust or a disabled person’s trust? Which one should you choose if you’re thinking about setting up a trust for an adult with learning disabilities?
There are various types of trust that can be used to provide for the support of a disabled or vulnerable person.
A trust is an arrangement that allows assets such as property, cash and investments to be held on behalf of a beneficiary or several beneficiaries. The assets are placed under the control of trusted people called trustees. The trustees manage the assets held in the trust and decide how to use them for the benefit of the beneficiaries.
Discretionary trusts and disabled person’s trusts are the types of trust used most often for supporting people with learning disabilities.
Why use a discretionary trust?
Discretionary trusts are popular because they are very flexible. Discretionary trusts allow the trustees wide powers. That flexibility enables the trustees to use the trust assets to meet the individual needs of a beneficiary more easily. The trustees can adapt the way they apply the assets to match the changing circumstances of the beneficiaries. For example, they don’t have to release money every year from the trust if it’s not needed.
Discretionary trusts must have more than one beneficiary. It’s usual to include other family members in addition to the disabled person and possibly a charity as a back-stop beneficiary.
The trustees of a discretionary trust have absolute power to decide which of the beneficiaries are going to receive a benefit from the trust. This means that none of the beneficiaries has a fixed entitlement to anything from the trust. They only have a potential right to receive something from the trust.
Discretionary trusts can avoid adversely affecting entitlement to means-tested benefits
If a disabled person is named as a beneficiary of a discretionary trust the trust assets won’t be taken into account when the person is being assessed for means-tested benefits or local authority care funding.
Tax and discretionary trusts
Although there are clear advantages to using a discretionary trust for a disabled person there are some potential drawbacks. The way these types of trust are taxed can be a disadvantage so they do need careful consideration before setting one up.
Inheritance tax is charged when a discretionary trust is set up if the value of the trust fund is over the IHT nil rate limit (currently £325,000). Inheritance tax is also charged every ten years if the value of the trust is more than £325,000 at that time. There could be further IHT charges when payments are made from the trust.
Discretionary trusts also attract higher rates of income tax and capital gains tax than some other types of trusts.
How does this compare with a Disabled Person’s Trust?
A Disabled Person’s Trust is similar to a discretionary trust in that the trustees also have wide powers over how they manage the trust assets and use them. There is a big difference, however, which is that more advantageous tax rules apply to a disabled person’s trust.
A disabled person’s trust must benefit a person who is defined as:
- 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; or
- in receipt of Disability Living Allowance (DLA) by virtue of entitlement to the care component at the higher or middle rate; or,
- in receipt of Personal Independence Payment (PIP) at the standard or enhanced rate for ‘daily living activities’.
A Disabled Person’s Trust qualifies for reductions in income tax and capital gains tax. They also qualify for exemption from Inheritance tax in some situations. The trust must be one where:
- the trust was set up before 8 April 2013 and at least half of the payments from the trust go to the disabled person; or
- the trust was set up on or after 8 April 2013 and all payments go to the disabled person, except for up to £3,000 per year (or 3% of the assets, if that’s lower), which can be used for someone else’s benefit
- the trust was set up when someone who suffers from a condition that’s expected to make them disabled sets up a trust for themselves.
There’s no Inheritance Tax charge:
- if the person who set up the trust survives 7 years from the date they set it up
- on transfers made out of a trust to a vulnerable beneficiary
But it’s worth noting that when the beneficiary dies, any assets held in the trust on their behalf are treated as part of their estate and Inheritance Tax may then be charged.
Disabled person’s trusts are exempt from 10-year Inheritance Tax charges.
Which trust is best?
A Discretionary Trust is often more suitable where the tax implications are not likely to be a major consideration. Discretionary trusts are best where maximum flexibility is required to provide for several people in the family.
A disabled person’s trust is useful when tax is likely to be a major issue and there are no other family members who have financial needs.
What should you take into account before choosing a trust?
It’s very important to give careful thought to your family’s finances. Think about the present and future needs of the disabled person and the circumstances of other members of the family. Each trust should be individually tailored to fit to ensure the right type of trust is chosen.
It’s important to set it up a trust in the best way for you and your family; so there’s a lot to consider. Our BE My Own Lawyer service can help you with tips, FAQs and case studies. Our revised, updated web-based service for people who want to learn how to create trusts will be available shortly.