Nadia Cowdrey discusses how to utilise trusts to plan for your disabled child’s future in FT Adviser

It’s natural to worry about how your loved ones will cope financially and emotionally after you are gone, more so if they are vulnerable and dependent on you. Fortunately, only a small number of young children find themselves orphaned, but what if your child will remain dependent on you well into adulthood? Arguably, gone are the days when any child flees the nest at 18 for further education or work never to return to the family home as a dependant again. But ignoring that modern day phenomenon, the reality facing parents with a vulnerable child, whether through physical disability, mental disability or both, is that they need to think carefully who will fill their parental shoes after they die or become incapacitated, and how their child’s physical, emotional, and financial needs will be met.

Putting off discussions about dying explains why so many adults in the UK do not currently have a Will, and planning is often delayed until we have a sense of our own mortality, usually as we advance in age or become ill, but for parents with a vulnerable child, the fear for their child’s future is strong from the early years. It’s not just a case of ensuring they are financially secure, more fundamental is who will look after them and what they will be entitled to in terms of state funded benefits.

Whilst some vulnerable adults can work and lead fulfilling lives with the right support network, many may never be able to work and look after themselves and will be entitled to state benefits, such as Disability Living Allowance for under 16’s and Personal Independence Payment (PIP) for over 16’s. Some benefits are means tested based on their financial position, and others are awarded based on physical and mental disability and needs. Citizens Advice have excellent website resources and advice on claiming these and other tied benefits.

The effect of an inheritance on means tested benefits can pose a dilemma for parents deciding how to plan. There is little point leaving assets to a child who may not be able to manage their own finances and will result in loss of entitlement to means tested benefits. After all, the welfare state was introduced to protect the most vulnerable in society, whether through financial hardship, disability, and old age, and they should surely avail themselves of that support.

The early years is arguably the easiest stage to secure help. After all, you are likely to be young, full of energy and feel your demise is decades away. And, more crucially, you and your child will have the support of the school, Special Education Needs Coordinators, Social Services, primary medical services and possibly a local charity specialising in supporting families with children with special needs. You may also be fortunate to have supportive family and friends taking an active part in your child’s happiness and well-being. But ask any parent navigating a move for their child from mainstream primary to secondary school or an educational institution for special needs, you can almost see the steam coming out of their ears as they relay the exacerbation of trying to secure the right education and emotional support. Sadly, things tend to get tougher as each year passes.

A small child who might be frustrated and showing aggression is easier to restrain and protect than a full-grown adolescent or adult. An unfortunate facet of human tolerance is that youths and adults with special needs often struggle to get the same understanding, support, and kindness as youngsters. So, add that to the fear of who will look out for them once their parents have died, it is no wonder that parents worry enormously about their child’s future.

Seeking professional advice is essential and will enable you to plan who will care for your child, who will manage their finances, how you can provide for them in the most tax efficient way and ensure flexibility long into the future. This is likely to involve Wills including a Trust, possibly coupled with a lifetime trust, Lasting Powers of Attorney relating to property and finance and health and welfare, and if mental capacity is lacking – a deputyship application to the Court of Protection. Understanding the impact of Inheritance Tax, Capital Gains Tax, Income Tax and the welfare benefits system is essential when deciding on the most appropriate course of action.

A Trust is usually central to planning and although everyone’s circumstances are different, the main Trust options are usually a Discretionary Trust or Discretionary Disabled Persons Trust. Each has its own advantages and considerations, particularly regarding tax implications.

1. Discretionary Trust

A Discretionary Trust is a Trust where the Trustees have discretion regarding distribution of income and capital to all or any of the potential beneficiaries listed. This would obviously include the vulnerable child but would need to name others to whom distributions could be made if funds are still held in the trust after the vulnerable child’s death.

Tax considerations and the value and type of assets which go into the Trust will be key drivers in determining whether this type of Trust should be set up or a Disabled Person Discretionary Trust.

IHT – you cannot transfer more than £325,000 each into this type of Trust without triggering an immediate charge to IHT at the lifetime rate of 20% on the excess. Survival by seven years would mean that the value settled is excluded from your estate for IHT purposes.

During the lifetime of the Trust, there is the possibility of a charge to IHT every 10 years, to the extent that the value of the Trust at the time exceeds the IHT nil rate band (currently £325,000) – up to 6%. And if IHT applies at that stage it will set the rate of IHT that applies to distributions of capital in the following 10 years.

The upside for IHT purposes is that whatever is held in the Trust is not part of the vulnerable child’s estate for IHT purposes and will not suffer a charge to IHT on their death.

CGT – a transfer into this type of Trust is a deemed disposal for CGT purposes. Because the Trust is potentially chargeable to IHT on creation (if you exceed your IHT nil rate band – normally £325,000) and has the potential for 10 yearly and capital distribution exit charges, there is the option of “holding over” CGT which would normally be payable on creation. A transfer into this type of Trust is a deemed disposal for CGT purposes and CGT is calculated in the same way as it would be if you sold the asset and triggered a capital gain. You can sign an election with HMRC to “holdover” the capital gain so that the Trust acquires the asset based on your original acquisition value. It does not avoid CGT, it merely passes on the liability to the Trust. Under current rules, if the Trustees then distribute the asset with the inbuilt gain to a beneficiary, they can sign one more “holdover” election so that the beneficiary who owns the property has the inbuilt gain. Retaining the asset until their death would washout the capital gain although, the asset would then be included in their estate for IHT purposes.

The Trust can realise capital gains each year exempt up to the Trust limit, currently £1,500.

Income tax – a downside of this type of Trust is that income is liable to income tax at the rate applicable to trusts:

• Trust income up to £1,000 is taxed at the standard rates of:

Dividend income            7.5%                     All other income              20%

• Trust income over £1,000 is taxed at the following rates:

Dividend income            39.35%                  All other income           45%

That said, if income is distributed to a non/low rate taxpayer, they can reclaim the difference from HMRC between their rate and the Trust rate.

2. Disabled Persons Trust

This is a hybrid of a Discretionary Trust and has certain tax breaks as the Trust must predominantly be used for an individual who is classified as a vulnerable person.

IHT – unlike the Discretionary Trust referred to above, there is no possibility of IHT applying when an asset is transferred into the Trust. This is because it is not a chargeable transfer for IHT purposes; it is a potentially exempt transfer. This means more than £325,000 can go into the trust without triggering IHT.

Unlike a standard Discretionary Trust, this type of Trust is not part of the IHT relevant property regime, so does not incur possible IHT on each 10th anniversary and on distributions of capital. However, for IHT purposes, the capital value would be treated as comprised in vulnerable child’s estate when they die. If above their IHT nil rate band and any other allowances available, there would be a charge to IHT at the rate prevailing at the time, currently 40%.

CGT – there is favourable CGT treatment on gains arising on assets held in the Trust. If an asset is sold which has made again, the full CGT allowance applicable to an individual is available, although it’s hardly much to get excited about – a mere £3,000.

However, a disadvantage with this type of Trust is that because there can be no charge to IHT when it is created nor indeed during the lifetime of the Trust, HMRC do not currently give you the ability to holdover capital gains on creation. In consequence, there would be a significant CGT charge if the trust receives assets which have risen in value, such as investments or a property.

Income tax – this is the real benefit of a Disabled Person’s Trust; assets producing an income will benefit from the vulnerable child’s personal income tax allowance and their low marginal rate of tax which could mean very little, if any, income tax on income produced by the Trust.

Key considerations when choosing

1. Assets to be transferred: The type and value of assets can influence which Trust is more suitable.
2. Tax implications: Consider both immediate and long-term tax consequences.
3. Beneficiary’s needs: Ensure the Trust structure aligns with your child’s specific requirements.
4. Administrative burden: Consider the ongoing management and who would be suitable Trustees.

Given the complexity of Trust structures and tax implications, it’s essential to seek professional legal and financial advice. An experienced solicitor can:

• Assess your specific situation
• Explain the pros and cons of each option in detail
• Help you make an informed decision
• Assist with trust creation and required reporting to HMRC

Remember, while tax efficiency is important, the primary goal is to ensure your child’s long-term well-being and financial security.

By carefully considering your options and seeking professional guidance, you can create a robust plan that provides for your disabled child’s future, giving you peace of mind and ensuring their needs are met for years to come, without impacting their entitlement to state benefits. For more information about setting up a Disabled Person’s Trust please contact a member of our Private Client team.