A personal injury trust is the name given to trusts which are usually set up by solicitors from payments as a result of an accident, injury or malpractice.
What is a Personal Injury Trust
A personal injury trust is the name given to trusts which are usually set up by solicitors from payments as a result of an accident, injury or malpractice. The funds normally are paid directly via the solicitor and into a suitable trust. They are normally either absolute or discretionary in nature and the settlor of the trust is normally the injured party. The solicitor is usually responsible for drafting a suitable trust. For the avoidance of doubt, the term “personal injury trust” has no statutory basis.
Disregard for Means Tested Benefits
Due to the nature of the source of the funds, the payment into the trust is disregarded for the capital means test under legislation, if paid within 52 weeks of settlement. It should be noted that the 52 week period starts from the first or interim payment so a trust should be established at this point.
If the trust fund is derived from payment in consequence of any personal injury to the claimant (income Support (General) Regulations 1987 S46(2)) it’s disregarded from the capital means test.
It is the source of the funds that dictate that it’s a Personal Injury Trust.
The main consideration of the trust is to protect any “care package” that is funded by the Local Authority in order that the capital and income of the trust is not taken into consideration and used up to pay for care. It protects clients who are in receipt of means tested benefits including -
Council Tax Reduction
Employment and Support Allowance
The trustees can pay for any capital items that are required by the settlor i.e. a specially adapted home, specialist equipment, replacement household goods etc. The trustees can pay for holidays for the injured party and carers but they will not normally remit “income” directly to the beneficiary’s bank account so as not to interfere with means tested benefits.
If the individual is eligible, the trustees may be able to claim special tax treatment in the form of a “vulnerable person election” and the trust will be treated and taxed as a “vulnerable trust”. The relevant form is VPE1.
Where the settlor is the only person capable of benefitting, then the gift into trust is not an occasion of charge given that nothing is leaving the estate and the trust property simply forms part of the estate. Similarly, where the settlor ‘self-settles’ into a ‘disabled trust’ (S89 IHTA 1984) as referenced above, then again the property has not left the estate for IHT purposes.
Any income tax and capital gains tax will be assessed on the settlor of the absolute trust at their own tax rates. This means the settlor can utilise their personal allowance, savings rate, personal savings allowance and the dividend nil rate. They can also utilise their own capital gains tax annual exempt amount.
On the death of the settlor the value of the trust will form part of the estate and the executors will deal in accordance with the will or intestacy rules.
Taxation of Discretionary Personal Injury Trust
Under a Discretionary trust the gift creates a chargeable lifetime transfer (CLT) if there are other beneficiaries and the disabled trust conditions for IHT are not met. In that event, the gift may attract an entry charge if the value of the gift when added to any other CLTs made in the previous 7 years exceeds the settlor’s current nil rate band. In broad terms, there may therefore be a tax disincentive for settling funds in excess of £325,000.
Any income tax will be initially assessed on the trustees at the trustees rate of tax. However, as this is a “settlor interested” trust, the income will also be assessed on the settlor who will get credit for the tax paid to set against his/her own income tax liability.
There are no settlor interested rules for capital gains tax. Any tax due will be levied at the trustee rate of tax over the annual exempt amount applicable to trusts. This amounts to half of the annual exempt amount for individuals divided by the number of trusts created in the settlor’s lifetime up to a maximum of 5.
Discretionary trusts may also be subject to periodic charges every 10 years and exit charges which are explained in our Estate Planning Guide on our website.
On the death of the settlor the trustees will administer the trust fund in accordance with the trust deed. The settlor may create a letter of wishes to give them guidance on whom they want to benefit from the trust after their death.
Any investments made will be in the name of the trustees who are responsible for the assets within the trust.
Normally the trustees have wide investment powers and can invest in any asset that a prudent person would invest in which includes Bonds, OEICs and bank accounts.
Remember that trustees can take advantage of the 5% tax deferred withdrawal facility from a life assurance bond under chargeable event legislation. This means that only amounts that exceed the allowance will be assessed for tax. This is a very useful facility as trustees can accrue the allowance and use it to take capital out of the bond when it is needed whilst deferring the tax.
On 7 November 2018, HMRC issued a consultation document “The Taxation of Trusts: A review”. In simple terms, the consultation sets out the government’s thinking on making trusts fairer, simpler and more transparent. At the time of writing, the government is not making specific proposals for reform. Instead, the government will weigh up the views and evidence presented and consider the options for targeted reforms.