03.08.16

Question:

I know I need to set up a Trust for my daughter who has a learning disability, I’ve heard about both a Discretionary Trust and a Disabled Person’s Trust, but which one do I need?

Answer:

As you probably know, a Trust is the best way of financially providing for a disabled or vulnerable person throughout their lifetime.  A Trust allows for assets (such as property, cash and investments) to be held by trusted individuals (known as Trustees) for the benefit of others, in this case a disabled or vulnerable person (known as the beneficiary or beneficiaries).  It is the Trustees who decide how to use the assets for the benefit of the beneficiaries and they will be governed by any rules set out in the Trust document.

A Trust can be set up to meet your individual circumstances and the needs of your family, in particular, those of your daughter.  The two most common types of Trusts used to provide for a disabled or vulnerable person are Discretionary Trusts and Disabled Person’s Trusts and before you can decide which is best for you, it is important to understand how each works.

Discretionary Trust

A Discretionary Trust involves the Trustees having full flexibility to decide how to use the assets (including the capital and income) for the benefit of the beneficiaries.  The Trustees have full discretion to use the assets in any way to meet the needs of any beneficiaries at any time.

With this type of Trust there must be more than one beneficiary so it would be advisable to include your daughter, along with any other children, wider family and possibly a charity.

None of the beneficiaries have any fixed entitlement to receive money from the Trust and only have a potential right to receive something if the Trustees choose to do so.  This means that the Trust and its assets cannot be taken into account when assessing your daughter’s entitlement to means-tested benefits or Local Authority funding.

So, the advantage of a Discretionary Trust is that the Trustees can make decisions to meet the changing requirements of your daughter during her lifetime.  The Trustees can use their discretion to advance any amounts of capital or income to her depending on her needs at different times in her life.

Although a Discretionary Trust is very useful, the tax treatment is not favourable and needs to be carefully considered. If the value of the Trust exceeds the Inheritance Tax threshold (currently £325,000) there will be an Inheritance Tax charge when the Trust is set up.  There will also be an Inheritance Tax charge every ten years and then whenever a payment is made from the Trust.  The tax rates for Income Tax and Capital Gains Tax are higher in this type of Trust.

Disabled Person’s Trust (DPT)

A DPT is a Trust set up to specifically to benefit a ‘disabled person’ and is largely similar to a Discretionary Trust.

For the purposes of this trust, a disabled person is defined as someone 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; 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’.

As with the Discretionary Trust, the Trustees can use the capital or income for the benefit of the disabled person and they have full discretion as to how they do this.

The main advantage of a DPT over a Discretionary Trust is the favourable tax treatment it receives for Inheritance Tax, Income Tax and Capital Gains Tax.  The tax rules need some consideration but, in general, the tax paid in a DPT can be minimal or, in some cases, no tax needs to be paid.

However, you also need to be aware that, in order to qualify for the favourable tax treatment, the Trust must be set up in a way that, during your daughter’s life, the income and capital will be wholly applied for her benefit.  This is subject to a small exception that the lesser of £3,000 or 3% of the value of the trust fund (either income or capital) can be applied to another beneficiary of the Trust in each tax year. 

So, which type of trust is more appropriate?

This will entirely depend on your circumstances and those of your daughter and we would firstly look at some important factors such as:

• your daughter’s age;
• the nature and the long-term prognosis of her disability;
• any benefits and funding she receives;
• the needs of other family members and the value of your assets.

If your daughter meets the criteria for a Disabled Person’s Trust then we can directly compare the differences between both types of Trust and the implications for your daughter and your family.  A Discretionary Trust is usually more suitable where the tax implications are limited, because the value of the fund is lower and the assets aren’t producing high income or gains, and when maximum flexibility is required to provide for other people.  A Disabled Person’s Trust is used when tax is likely to be a significant problem and there is not a great need to provide for others.

By carefully considering all of the factors, you will be able to put in place the right type of Trust which can provide the long term financial support for your daughter.

Please do not hesitate to contact us to discuss your specific circumstances in more detail.