This article provides an overview of the income and capital gains tax reliefs and the special inheritance tax rules which can apply where there is one or more vulnerable or disabled beneficiary.
The term ‘disabled persons trust’ is frequently used to describe any trust where a beneficiary is deemed vulnerable or disabled. However, this isn’t a specific type of trust. A disabled persons trust can be any discretionary, interest in possession or absolute trust. The key is whether the beneficiary’s vulnerability qualifies the trust for income and capital gains tax (CGT) relief or if their disability qualifies the trust for special inheritance tax (IHT) treatment.
Who qualifies as a vulnerable or disabled beneficiary?
Vulnerable only:
- A child under 18 where at least one parent has died - known as a 'relevant minor'
Vulnerable and disabled:
- A person with a mental health condition covered by the Mental Health Act 1983
- A disabled person who is eligible for any of the following benefits (even if they’re not receiving them):
- Adult disability payment
- Armed forces independence payment
- Attendance Allowance
- Child disability payment
- Constant attendance allowance
- Disability living allowance (for adults or children)
- Industrial injuries disablement benefit
- Personal independence payment
Income tax and CGT relief
Trusts with a vulnerable beneficiary can make a ‘vulnerable beneficiary election’ with HMRC allowing them to qualify for income tax and capital gains tax (CGT) relief.
Calculating the relief
Where the trust has a liability to income or capital gains tax, they may be eligible for a deduction. This is calculated as follows:
- Trustees calculate the trust’s tax liability - using the trust rates of tax and assuming no relief
- Trustees then calculate the tax liability the vulnerable person would have on the same income / capital gains if taxed at their marginal rate.
- The trustees claim the difference between these two figures as a deduction on their tax liability.
The relief is not always relevant
The relief only applies if it is the trust which is liable to the tax. For example, a discretionary trust in receipt of interest and dividends. Absolute trusts already place the income tax and capital gains liability on the beneficiary directly and so the relief is not necessary.
Higher CGT exemption
Trusts eligible for the vulnerable beneficiary election will have a higher CGT annual exempt amount. This is currently £3,000 (2024/25, usually £1,500). Though this allowance may be reduced where the settlor has created multiple trusts.
Trusts which hold investment bonds
Bonds are taxed under chargeable event rules, chargeable gains are tax as income. Under these rules the settlor of a discretionary or interest in possession trust is liable to income tax on gains arising during their lifetime or tax year of their death. The trustees only have a liability in the following tax years. Even then, the bond can be assigned directly to a beneficiary to be taxed at their marginal rate. Therefore it may not be necessary for the trustees to make the vulnerable beneficiary election. Our guide can help you assess who is liable to tax on bond gains.
If the trust has multiple beneficiaries
If there are beneficiaries who do not qualify as vulnerable, then the trustees must segregate assets held for them. The relief only applies for the portion of the trust fund held for the vulnerable beneficiary.
If there is more than one vulnerable beneficiary, then the trustees must make an election for each.
Claiming the relief
Trustees must first submit a vulnerable beneficiary election form (VPE1) to HMRC. If there is more than one vulnerable beneficiary, then one form must be submitted for each.
Trustees claim the income tax and CGT relief when submitting their annual self-assessment (SA900). Self-assessment must be completed by 31st January following the end of the tax year.
The relief ends on the death of the vulnerable beneficiary, or if they cease to qualify.
Calculating the relief can be complicated, trustees should consider engaging an accountant. Example calculations are available from HMRC.
Inheritance tax
A trust may receive special IHT treatment where one of the following applies:
- One or more beneficiary is disabled or has a condition which is expected to make them disabled.
- The trust is a ‘bereaved minors’ trust. This is where one or more of the beneficiary’s parents has died creating a trust in their Will (or via the rules of intestacy) for their minor child.
The following special treatment is applied:
- A gift to a disabled persons trust is a Potentially Exempt Transfer (PET) regardless of the type of trust used. This means there will be no 20% entry charge for exceeding the nil rate band.
- Trusts will not be subject to the 10 yearly periodic or exit charges.
Restrictions on the trust fund
To qualify, there are restrictions which must be followed:
- For trusts created before 8 April 2013, at least half of the payments from the trust must go to the disabled person during their lifetime.
- For trusts created on or after 8 April 2013, all payments must go to the disabled person. However, up to £3,000 per year (or 3% of the trust’s value, if lower) can be paid to other beneficiaries.
- Trusts of bereaved minors (trusts created by the Will of the child’s parent) must pay all assets to the beneficiary on attaining age 18 or before.
Whilst it is possible to use a standard draft trust deed. A settlor of a disabled persons trust may choose instead to instruct a legal adviser to draft a bespoke trust document which enforces these restrictions on the trustees.
On death of the beneficiary
Any part of the trust fund held for a disabled beneficiary is treated as part of their estate for the purposes of calculating their IHT liability.
Claiming the special treatment
There is no election or application required for the treatment to apply. However, trustees and settlors are advised to keep good records which can help them demonstrate that the special treatment applies if needed.
Trust registration
Trusts for disabled beneficiaries or bereaved minors are exempted from registration during the lifetime of the disabled beneficiary. If the trust ceases to qualify for special treatment the trustees must register the trust within 90 days.