Understanding personal injury trusts

Introduction

This briefing is a high-level guide to personal injury trusts. As this is a complex subject specialist tax advice may be required. 

Where an individual has had an accident or injury and compensation has been awarded, it may not be possible or appropriate for the injured individual to hold these awards directly. The creation of a suitable trust, such as a personal injury trust, may be required to hold and manage these funds.
 

Core considerations

• The trust ring fences the compensation. Personal assets should not be added to the trust. 
• The compensation is disregarded when assessing the individual’s eligibility to means tested benefits.   
• Some trusts may restrict which investments can be chosen by the trustees.   
• Personal injury trusts are settlor included trusts for tax purposes.
• The trust could be treated as a vulnerable person and disabled beneficiary trust and could benefit from specialist tax treatment.

Contents

• Types of personal injury trusts
• Protecting means tested benefits 
• Payments from the trust to the individual 
• Investments 
• Taxation

Types of personal injury trusts

Individuals who have been awarded compensation because of a personal injury can often be advised to set up a personal injury trust. This can be used towards the payment of care, equipment, modifications to the home or ongoing treatment of the individual. 

The trust ring-fences the compensation from the individual’s personal assets and gives the trust the status of a personal injury trust. If personal funds, that do not relate to the compensation, are added to the trust, it will lose its status. 

Personal injury trusts are drafted on a bespoke basis by the individual’s solicitor. Each type has its advantages and drawbacks and will be specific to the individual’s circumstances and needs which would have been discussed when the trust deed was drafted.

They can be set up as:

1. A discretionary trust - this is likely to provide the most flexibility. The individual is included as within the class of beneficiaries. The trustees will have the discretion to appoint income and capital, depending on the needs of the beneficiary; or
2. An absolute trust - the individual will be entitled to income and capital from the trust.
3. An interest in possession trust – the individual will be entitled to income from the trust. The trustees can appoint capital to the individual, if needed.

The person who has been awarded the compensation will be the settlor and a beneficiary of the trust. When the trust is created, the compensation is transferred to the trustees to hold and manage it for the benefit of that individual.   

Where a deputy or guardian has been appointed to act for an individual, they can create a personal injury trust for them. The Court must authorise this before the trust is created. 
 

Protecting means tested benefits

One of the main benefits of a personal injury trust is the compensation payment isn’t regarded as a personal asset. The compensation is disregarded when assessing the individual’s eligibility to means tested benefits.

The trust must be set up within 52 weeks from the date the compensation is awarded for it not to be included in the assessment. This includes the date that any interim payments are paid.   

If the payment isn’t immediately put into a personal injury trust, the amount will be regarded as a personal asset until it is placed into trust.
 

Depending on the individual’s circumstances, they may not qualify for means tested benefits today but they could qualify in the future. Creating a personal injury trust for the compensation payment removes it from any future assessment.

Payments from the trust to the individual

Income and capital paid from the trust to the individual loses its protection. These payments become personal assets and will be included in the means tested assessment. This can result in the benefits being reduced or lost completely.  

If the individual has specific needs for items, such as equipment, the trustees could buy them for the individual to use. If the trustees own the items, the individual’s entitlement to means tested benefits will not be affected.
 

Investments

Trustees can apply for and own most investments, provided the trust provisions do not restrict the type of investments that they can invest in.  

If the trust doesn’t include any restrictions they could invest in most mutual funds, National Savings products, and onshore and offshore investment bonds.  

Not all investments would be suitable, for example an Individual Savings Account can’t be owned by trustees.
 

Taxation

Personal injury trusts can benefit from specialist tax treatment. The trustees can make an election to HMRC, for it to be treated as a vulnerable person and disabled beneficiary trust. 

Certain conditions must be met each year for the trust to benefit from specialist tax treatment. These rules are complicated and restrict who can benefit. The trustees may want to consider these complexities and restrictions before making any election and consider obtaining specialist tax advice.
 
If trustees do not make an election, personal injury trusts are regarded as settlor included trusts for tax purposes.

The following table illustrates:

• who will be assessable when income and gains are generated within the trust, whilst the settlor (the individual who was awarded the compensation) is alive, and  
• the inheritance tax position when they die. 

	Discretionary and Interest in Possession trust	Absolute trust
Income	The settlor is assessable. The trustees must pay the tax. Credit is given to the settlor for the tax deducted by the trustees at a rate of 45% (39.35% dividends) for Discretionary trusts and 20% (8.75% dividends) for Interest in Possession trusts.	The individual is assessable as an absolute beneficiary.
Capital gains	The settlor is assessable.	The individual is assessable as an absolute beneficiary.
Inheritance tax	The value at the date of death will fall within the settlor’s estate.	The value at the date of death will fall within the individual’s estate, as an absolute beneficiary.

Where the trustees have invested in an investment bond (life assurance or redemption version) the individual will be assessable on any gain, as settlor, if the trust is a discretionary or interest in possession trust. If it is an absolute trust, the individual will be assessable as an absolute beneficiary.

The individual can make full use of any unused personal and savings allowances when calculating the taxable gain and reliefs, such as top slicing.