For those with concerns around how they might provide for vulnerable loved ones in future, trusts can provide a valuable planning opportunity – but should also be approached with caution.
"Disappointed? Why should I be disappointed? I got rose bushes didn't I... he got three million dollars but he didn't get the rose bushes. I got the rose bushes."
Film buffs might recognise this as a quote from the 1988 classic, Rain Man, in which the hitherto selfish and superficial Charlie Babbitt (played by Tom Cruise) embarks on a (literal) journey of self-discovery, when his father leaves his $3 million fortune in trust for his brother Raymond, who Charlie didn't know existed. Raymond Babbitt (Dustin Hoffman) is a man with autism who has Savant Syndrome and has been in residential care for most of his life.
Disregarding many of the film's more theatrical aspects (abduction, a cross-country voyage in a very fetching 1949 Buick Roadmaster, and card counting in Las Vegas among others), it serves to highlight a very real concern for many – what mechanisms exist to help us support our vulnerable loved ones throughout their lives? Trusts often represent a flexible and pragmatic solution and, in this way, Charlie and Raymond's father's choice to include one within his will is true to life (albeit, legacies of rose bushes are encountered somewhat less frequently).
In this article, we'll consider the benefits of using a trust structure, highlighting those that are particularly relevant and helpful for potentially vulnerable beneficiaries.
Adopting a trust structure
It is not uncommon for individuals to feel that it would be inappropriate to pass significant assets (either during life or under the terms of a will) to particular loved ones. They may feel that these potential beneficiaries have not yet developed the maturity or experience to manage the assets, or they may have other concerns about their wider life circumstances.
In this scenario, although various different types of trust are available, a discretionary trust is a popular vehicle. In this type of trust, assets are held and managed by trustees selected by the donor (which may include the donor), who retain discretion over how and when the assets, or any income generated, are passed on to the beneficiaries of the trust. They will often be guided by a 'letter of wishes' created by the donor at the trust's inception.
The main benefits of this structure are flexibility and asset protection as the assets do not form part of the beneficiaries' personal estate until they are transferred out of the trust. There is also a connected benefit in protecting certain means-tested state benefits, as beneficiaries are not deemed to have a particular entitlement to either trust capital or income.
With the above in mind, it is important to be aware that trusts come with administrative costs, as well as tax consequences. For example, there might be charges to Inheritance Tax when assets are initially transferred into the trust, on each ten-year anniversary of the trust's creation, and when assets exit the trust. Upon closer examination, these costs may be prohibitive.
Over and above the standard discretionary trust, lawmakers have used statute to create two variations (collectively termed 'Vulnerable Person's Trusts'), which are liable to receive preferential tax treatment, so long as they adhere to strict rules. These trusts are summarised below.
Trusts for bereaved minors
The law recognises a 'trust for bereaved minors' where a parent (or a step-parent) creates a trust in their will that provides for the child while they are under the age of 18. As long as the trust assets are moved over to the child upon turning 18, this type of trust is exempt from the Inheritance Tax regime referenced above.
It is possible to extend the life of this type of trust, such that the child may benefit up to the age of 25. While this type of trust (often termed an '18 – 25 Trust') retains many of the tax benefits of the trust for bereaved minors, assets made over to the child between the ages of 18 and 25 may incur an Inheritance Tax charge, making the protection less extensive than trusts for children under the age of 18.
Disabled Person's Trust
Trusts which fall within the statutory definition of a 'Disabled Person's Trust' are also exempt from the Inheritance Tax consequences usually associated with a discretionary trust, as well as preferential treatment for Income Tax and Capital Gains Tax.
The format of the Disabled Person's Trust is, however, quite restrictive. For example, the definition of a 'disabled person' set out in the relevant legislation is restricted to an individual who lacks capacity by reason of mental disorder or who is in receipt of certain state benefits, as at the date of creation of the trust. This not only serves to narrow the range of individuals who will be eligible beneficiaries if the trust is created during the donor's life, but it limits the benefit of including such a trust within a will, as the testator cannot predict what the relevant individual's circumstances may be when the trust is created upon their death.
Conclusion
Vulnerable Person's Trusts come with serious tax advantages but must be navigated carefully if they are to receive the preferential treatment envisaged.
This article was co-authored by Trainee Vambo Maswiswi.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
