This article will provide you with an overview of personal injury trusts, how they’re created and their tax treatment.
What is a Personal Injury (PI) Trust?
There’s no fixed definition of a PI trust, it’s not a type of trust in itself - it’s a description of the trust’s purpose. A PI trust can be any absolute, discretionary or interest in possession trust which is settled using a payment awarded under a personal injury claim. Examples include:
- An accident caused by the negligence of another party.
- Medical negligence.
- Criminal act by another party.
Usually the award will be a payment ordered by the court or an agreed settlement figure. But it can include charitable donations, insurance claims and payments from government compensation schemes. The payments must have been made directly as a result of the injury.
The injured person is usually deemed to be the trust’s settlor (creator).
Why use a Personal Injury trust?
Capital and income with a PI trust is disregarded for means tested benefits.
For most this is the main benefit of using a PI trust. Means tested benefits includes state benefits as well as local authority funding for the costs of living in a residential care home. Usually setting up a trust for this purpose is considered to be deliberate deprivation of assets and therefore ineffective. However, this does not apply to personal injury trusts.
To qualify the award must be settled into trust within 52 weeks. If the award is given in instalments, then this is from the date if the first payment. Any payments after the 52 week period will not be disregarded and should be kept separate from qualifying payments.
Structure and control
The settlor can choose their trustees and beneficiaries, allowing them to create a structure which suits them. They can also be a trustee, which means they remain in control of the award. As with any trust, the trustees can use the trust fund to support their beneficiary, such as covering living costs, equipment, home improvement and holidays.
Setting up a Personal Injury trust
The trust is usually created by the injured person’s legal adviser - though this doesn’t need to be the case. The injured person is free to have their own trust drafted, or use a draft deed offered by a provider of investment products, such as Quilter. In either case, legal advice is always recommended.
Loss of mental capacity
Brain injury can leave an individual without the mental capacity to act for themselves. In these cases, the Court of Protection must decide the most appropriate method for managing the award. A deputy may be appointed by the court to manage the affairs of the injured person. This is usually preferred to a trust because of the oversight provided by the office of the public guardian over the deputy’s actions. The award will still be disregarded for means testing if managed by a deputy.
Minor children
The courts will need to approve the suitability of any personal injury trusts created on behalf of a minor. A court of protection order may be deemed to be more suitable as outlined above.
Absolute, Discretionary or Interest in Possession trust
The award for a personal injury will generally be used to support the injured party, potentially paying for additional care costs, home improvements or supplementing reduced earnings. For this reason, most will be structured as an absolute trust with the injured person as the sole beneficiary. However, it is possible to use a discretionary or interest in possession trust if the injured person is included as a beneficiary.
A Discretionary trust gives the trustees the power of discretion over how and when the trust fund will be distributed.
An interest in possession (IIP) trust provides a beneficiary (life tenant) with the right to income for life with the trust capital passing to other beneficiaries (remaindermen) on the death of the life tenant. The injured party would usually be the life tenant.
Using these trusts can provide additional benefits when compared to an absolute trust, including:
- Succession planning on the death of the injured person.
Under an absolute trust, the assets are distributed in accordance with the beneficiary’s Will. Whereas a discretionary trust or IIP can continue for the remaining beneficiaries.
- Protection of the trust fund.
With a discretionary trust or IIP, the beneficiary does not have a vested (absolute) right in the trust capital and therefore cannot demand capital from the trust. This may be particularly useful if the injured person is not good with managing their own money.
Tax Treatment
Absolute trust
Inheritance tax
Where the injured person is the sole beneficiary of the trust, there will be no gift for IHT. The value of their estate remains the same after the creation of the trust. On their death, the value of their trust fund will be included in their estate. The trust fund would be paid to the legal personal representatives of the estate who would distribute it in accordance with the beneficiary’s Will or rules of intestacy.
Income tax and capital gains tax
Income and gains will be taxed at the beneficiary’s marginal rate of tax. They have full use of their available income and capital gains exemptions / allowances.
Discretionary / Interest in Possession Trust
Inheritance tax
Gifts to a these trusts are usually treated as ‘chargeable lifetime transfers’ (CLT). Where the cumulative value of all CLTs made by a settlor, in any 7 year period, exceeds the nil rate band - an entry charge of 20% applies to the excess. The nil rate band (NRB) is currently £325,000 and is frozen until 2028.
If the injured party meets the definition of ‘disabled person’, then the gift will be a potentially exempt transfer (PET) and the entry charge will not apply. The definition of disabled person is outlined in Schedule 1A of the Finance Act 2005. It includes those in receipt of disability related benefits. There are also restrictions on how much of the trust fund can be paid to beneficiaries other than the injured person. 3% of the trust fund per annum OR £3,000 if lower. For further details see our guide to trusts for vulnerable or disabled persons.
Regardless of how the gift is treated when made, the inclusion of the injured person as the beneficiary will trigger gift with reservation rules, the value of the trust fund will be considered as part of their estate for IHT purposes. However, unlike the absolute trust, the trust fund will not be distributed in accordance with the Will.
A periodic (10 yearly) and exit charges on capital leaving the trust may also apply unless the ‘disabled beneficiary’ definition and restrictions described above apply.
Income tax and capital gains tax
Discretionary Trusts - As the injured person is both settlor and potential beneficiary, the trust will be treated as ‘settlor interested’ causing income to be taxed at their marginal rate. This can be complex, please see our taxation of income in discretionary trusts guide for a summary.
Interest in Possession - Income is taxed on the life tenant (the person with the right to income) at their marginal rate.
In either case, capital gains will be taxed at the trust rate of 20%, with an exemption of up to £1,500 (depending how many trusts are created by the settlor). There is a tax relief if the injured person meets the definition of ‘vulnerable beneficiary’. This relief is equal to the difference between what the trust pays on the gains, compared to the tax the beneficiary would pay. Further reading is available in our guide to trusts for vulnerable or disabled persons.