07.02.23

There are many factors to consider when setting up a Trust for a disabled relative and, depending on the family circumstances, you are likely to set up a Discretionary Trust or a Disabled Persons Trust. There is no “one size fits all” and which Trust you choose to create should be considered carefully after taking sound professional advice.

A Discretionary Trust will usually allow the Trustees to have complete discretion to distribute the Trust funds to a number or “class” of beneficiaries. Whilst this is very flexible, such Trusts will pay income tax at the highest rate and, depending on the value of the assets within the Trust, Inheritance Tax will potentially be payable at each tenth anniversary of the Trust and when capital is distributed.

In comparison, a Disabled Persons Trust names the disabled person as the Principal Beneficiary who can enjoy unlimited benefit from the Trust funds during their lifetime. The Trustees still have some discretion over how much is distributed and can distribute funds to other discretionary beneficiaries within strict statutory limits. One of the main advantages of a Disabled Persons Trust is that the Trustees and the Principal Beneficiary can make a joint election to HMRC to tax the Trust income and gains at the personal rates of the Principal Beneficiary. Furthermore, there is no Inheritance Tax charge whilst the Principal Beneficiary is alive and remains a beneficiary of the Trust. Instead, the Trust assets are aggregated with the Principal Beneficiary’s personal estate when they die and if the combined assets exceed the nil rate band (currently £325,000) a charge to Inheritance Tax will arise. This is not an issue if assets are left to charity.

The needs and requirements of families can differ greatly and no two families are the same. Equally, circumstances can change significantly over time and what was appropriate when the Trust was first created might not be in the future. A common question that is asked is whether a Discretionary Trust can be transferred into a Disabled Persons Trust.

What to consider

When considering this question, it is vital to take professional advice to consider:

1. The circumstances of the family and the disabled relative;
2. The legal position and requirements;
3. The taxation position; and
4. Other administrative matters.

The Discretionary Trust will have a Trust deed which sets out the class or classes of beneficiaries, the terms of the Trust and the powers of the Settlor (the person who set up the Trust) and the Trustees. The Trust deed needs to be carefully examined to ensure that what is trying to be achieved is legally possible. The Trust deed may already incorporate powers for the Settlor or Trustees to transfer the Trust funds to another Trust or to add a new beneficiary (i.e. the new Trust). The terms of the original Trust will determine what action is possible and it is likely that further legal documentation will be required to make the desired transfer. The new Disabled Persons Trust will also need to be created and a Trust Deed executed to do so.

What about tax?

As well as the factors outlined above, it is also important to consider the taxation position of such a change. The consequences could be costly if this is ignored. There are three main taxes to consider:

1. Income Tax

The personal income tax position of the disabled person who will become the Principal Beneficiary of the Disabled Persons Trust needs to be examined. This is particularly important if the disabled person is already paying tax at the highest rate. If this were the case it would make the change of Trust irrelevant for income tax purposes because the discretionary Trust will already pay income tax at that rate. There are also administrative considerations to take into account. If the disabled person does not pay income tax at the highest rate they may currently have to make income tax repayment claims for distributions of income from the existing discretionary Trust. This may currently incur professional costs which might be avoided if a Disabled Persons Trust were created, the beneficiary had no other reportable income and the Trust income was taxed as if it belonged to the disabled person;

2. Capital Gains Tax

The Trustees also need to consider what assets are in the Discretionary Trust and whether there are any unrealised gains. When assets are transferred from one Trust to another they are deemed to be sold at market value by the original Trust and reacquired at that market value by the new Trust. This immediately realises the gains which are taxable. Such a tax charge may not be material and may be acceptable when considering the benefits of making such a change. However, extreme care should be taken to consider the capital gains tax consequences of the transfer of assets as the tax charge could be significant;

3. Inheritance Tax

Where assets are transferred from one Trust to another Trust, the current Inheritance Tax rules treat the transferred assets as still belonging to the original settlement, for tax purposes, until the assets are appointed out of the Trust to an individual. However, whilst this is the case, the Inheritance Tax treatment of Disabled Persons Trusts will still override the original Discretionary Trust inheritance tax regime for as long as the disabled person remains a beneficiary. Therefore, whilst HMRC will effectively treat the Trust as if the original Trust existed there can be no charge to Inheritance Tax until the death of the disabled person or until the disabled person ceases to be a beneficiary (if earlier).

At this point, if the transfer is considered to be beneficial, it would be prudent to consider the appointment of the Trustees of the new Disabled Persons Trust. Weighing up the pros and cons of appointing a corporate Trustee before the new Trust is created would be sensible.

Finally, the Trustees need to understand their statutory obligations in relation the Trust Registration Service (TRS). It is a legal requirement for all express Trusts to be registered on the TRS and any changes, or the creation of new Trusts, must be recorded within 90 days.

In summary, the answer to the question “can we transfer a Discretionary Trust to a Disabled Persons Trust?” is that it depends on the circumstances. You need to obtain proper advice to consider the needs of the beneficiary, review the original Trust deed, make any legal changes, draw up the new Trust document and very carefully consider the tax consequences of the proposed change. Then, if the change goes ahead, you need to make sure it is properly recorded on the TRS.

How can we help?

The specialist teams at Renaissance Legal and Renaissance Trust are happy to give advice and guide you through the process to enable you to achieve the most beneficial outcome. Contact us for a discussion about your situation.