Setting Up a Trust for Vulnerable Beneficiaries

Why an outright lump sum can do more harm than good

Most of us assume that leaving money to someone we love is straightforward kindness. In practice, a sudden inheritance can be a burden. A young person handed £150,000 at eighteen may simply not have the experience to manage it. Someone living with a condition that affects their judgement, or recovering from addiction, may find that money brings pressure from others as well as practical difficulties. And if the person you're providing for relies on means-tested benefits, cash in their own name can affect what they receive.

A trust is simply a legal arrangement in which one group of people — the trustees — hold and manage money for the benefit of someone else, the beneficiary. The beneficiary does not own the trust's assets outright. That is precisely the point: the trustees decide what is paid out, when and for what purpose, within the rules you have set out in the trust deed. You keep a measure of control long after you are gone, and the money is protected from being spent, lost or given away in a single afternoon.

The main types of trust for vulnerable beneficiaries

There is no single "vulnerable person's trust". The right choice depends on who you are protecting and why, and the tax treatment of each is genuinely different. The most common options are:

• Disabled person's trust and vulnerable beneficiary trusts. Where the beneficiary meets the tax definition of a disabled person — for example, they receive certain benefits, or are unable to manage their own affairs because of a mental disorder — the trust can usually be taxed as though the income and gains belonged to them. In many cases that means little or no tax, because their personal allowance and lower rates apply.
• Bereaved minor's trust. For a child under eighteen who has lost a parent. The child becomes entitled to the assets at eighteen, but until then the trustees manage everything.
• 18-to-25 trust. Similar in spirit, but the trustees keep control until the beneficiary reaches an age you choose, up to twenty-five. Often used where eighteen still feels too young.
• Discretionary trust. The most flexible option. Trustees choose who benefits, and when, from a group of people you name. It suits families who want maximum freedom, but it is generally taxed more heavily than the vulnerable beneficiary arrangements.

Trusts can be created in your will or during your lifetime. For most families, a will trust is the simpler route, because you keep access to the money while you are alive.

Don't overlook your protection policies

Many families think about trusts only in relation to what they own today. Yet life cover and critical illness cover are often the largest single sums a household will ever receive, and they tend to pay out at the worst possible moment. A payout on a policy that is not held in trust usually forms part of your estate, may attract inheritance tax, and cannot be released until probate is granted — which can mean months of waiting when the family needs money most.

Writing a policy into trust is normally a free and straightforward step. Points worth checking:

• Review the policies you already hold. Some older ones may never have been put into trust, but this can usually be arranged later.
• With combined life and critical illness cover, consider a split trust. This lets a critical illness payout come to you directly — useful if you need to adapt your home or replace income — while the life cover sits in trust for your family.
• Tell your trustees where the policy documents are kept and who to contact to make a claim.
• Note that trust assets are usually outside your estate for inheritance tax purposes, but a trust is not a way to hide money from creditors or from a fair financial settlement.

Choosing trustees who will do the job well

The trustees are the heart of the arrangement, and they should be chosen as carefully as the trust itself.

• Pick people likely to outlive you, and consider pairing a family member with a professional trustee such as a solicitor if the sums are large or the family is complicated.
• Appoint at least two trustees, and name a replacement for each.
• Choose people who communicate well with one another. Trustees who disagree can freeze the whole arrangement.
• Write a letter of wishes. It is not legally binding, but it tells your trustees what matters to you — education, housing, therapy, a holiday each year — and gives them confidence in their decisions.

If the beneficiary may never manage their own affairs, it is also worth putting a lasting power of attorney in place while you are able to, so that decisions about day-to-day matters do not have to go through the Court of Protection.

Cost, tax and benefits — the practical questions

Setting up a trust through a solicitor typically costs a few hundred pounds, plus a small annual charge for professional trustees where they are used. Compared with the sums involved, that is usually money well spent. Template documents exist, but they rarely cope well with the specific tax rules for vulnerable beneficiaries, and mistakes are expensive to unpick.

Two points catch families out. First, payments from a trust are generally treated as the beneficiary's income for means-tested benefit purposes, even though the trust's capital is not counted as theirs. Second, tax rules for these trusts have changed over the years, so a trust written a decade ago may not still do what you intended. Review it every few years, and whenever your family circumstances change.

Above all, talk to your family about your intentions while you are well enough to explain them. A trust works best when the people running it understand the person it is there to protect.