Disabled Person's Trust or Discretionary Trust

If you want to leave money to a disabled relative without it counting against their benefits, two trusts come up again and again: a disabled person's trust and a discretionary trust. Both can keep money and property out of means testing for benefits and social care, including supported living¹. Both are usually set up through a will. The difference is who qualifies, how the trust is taxed, and how much control the trustees have.

A disabled person's trust is for one person who meets an eligibility test, such as receiving a disability benefit at a particular rate. A discretionary trust needs a group of beneficiaries and leaves the trustees free to decide who gets money and when. On tax, independent guidance is blunt: "You will most likely pay more tax on a discretionary trust compared to a disabled person's trust"¹.

That does not settle the choice. A discretionary trust is more flexible, can be changed to a disabled person's trust if needed, and suits families who want other people to be able to benefit too². What follows sets out how each works, what each costs in tax and control, and where to get help.

Two types of trust for a disabled person

A disabled person's trust is set up for one person who meets an eligibility test. Guidance states you can set it up if the person is receiving a benefit that makes them eligible, including the care component of Disability Living Allowance at the middle or higher rate, or the mobility component at the higher rate, or if they are eligible as a vulnerable beneficiary, or lack the mental capacity to manage their finances¹. The trust usually lasts for the lifetime of the disabled person, but it can be shorter or longer¹. Money can come from an inheritance, compensation or a gift¹.

A discretionary trust works differently. It needs a group of beneficiaries, for example other family members or charities, and there is no legal recognition of a disabled person required¹. The trustees hold the money and assets on trust for your relative and decide whether or not to give them money, though you can give instructions on when you expect them to pay⁴. The structure is a pool of potential beneficiaries, with the trustees having discretion to benefit any of them².

A related idea is the vulnerable person's trust, which independent guidance says receives special tax treatment from HMRC, depends on the beneficiary's tax position, and is not subject to the 10-year inheritance tax charge⁵. If you are weighing up a trust set up during your lifetime against one created in your will, Will Trust or Lifetime Trust sets out how the two compare.

A disabled person's trust is likely to pay less tax

The tax gap between the two is the clearest difference. Independent guidance states that you will most likely pay more tax on a discretionary trust compared to a disabled person's trust¹. A vulnerable person's trust receives special tax treatment from HMRC, depending on the beneficiary's tax position, and is not subject to the 10-year inheritance tax charge⁵.

Inheritance tax works differently in each case. Assets placed into a discretionary will trust will not be exempt from inheritance tax, even if your spouse is one of the beneficiaries⁵. A disabled person's trust may not pay the same amount of inheritance tax as giving money and property directly to the person¹.

On capital gains tax, the trust annual allowance has an exception: it does not apply in the same way if the trust has been set up for someone disabled². On income tax, official guidance explains that for accumulation or discretionary trusts, income used to pay trust management expenses is deducted from income chargeable at the special trust rates and instead taxed at the lower rates for that type of income⁶. When trustees make a discretionary payment of income, it is treated by the beneficiary as if Income Tax has already been paid at 45%⁶.

There is a limit on how much can go to anyone other than the disabled person. For trusts arising on or after 8 April 2013, all the assets including income must be applied for the benefit of the disabled person, with up to £3,000, or 3% of the assets if lower, allowed to go to others each year⁷. Mencap's guidance puts the same limit in similar terms: no more than £3,000 or 3% of the value of the trust fund can be given to a person other than the disabled person each year².

Disabled person's trust or discretionary trust: weighing the choice

Tax is only one part of the decision. A discretionary trust gives flexibility to use your assets, property or money, as and when needed to meet the needs of your disabled family member with complex needs, without affecting means-tested benefits³. It is also flexible in another sense: guidance states it can be changed to a disabled person's trust if needed².

The trade-off is control. With a discretionary trust, the trustees decide how much and how frequently beneficiaries get the money, plus any conditions you set⁸. That can be a protection as well as a restriction. Trusts can make it harder for other people to financially abuse a disabled person, because trustees need to approve purchases¹. Your relative will not own the money in the trust, so they will not be able to spend it quickly or unwisely⁴.

There are drawbacks to weigh. Guidance notes there may be some tax disadvantages with a discretionary trust, which you would need to check with your solicitor⁴. It also warns that laws change, so there is no guarantee that money held in a discretionary trust will always be treated the same way in the future⁴.

The benefits position is the same for both, with one important exception. Money in a disabled person's trust does not count towards income or savings limits for means testing¹, and both types can stop money and property counting in means testing for benefits or social care, including supported living¹. But if trustees give the money directly to the disabled person, it counts towards income and savings, and could affect means-tested benefits or social care¹. Where a child is the only principal beneficiary, a discretionary trust set up correctly will not affect their means-tested benefits².

Setting up either trust through a will

Both trusts are commonly created in a will. Guidance states you can set up a trust as part of your will, as a way to support your disabled relative by protecting money or property⁹. A will can set up trusts¹⁰. A discretionary trust is usually accompanied by a letter of wishes, which gives guidance to the trustees on how the settlor would like the assets to be used⁵. Trust documents can include a letter of wishes covering how trustees should help pay for care and improve quality of life¹.

A trust should be separate from the will if you have a pension, death in service benefits or life cover, or when other people want to contribute¹. That is because these payouts do not pass through your will. If you are making or updating a will, Making a Will: Options, Costs and What Makes It Valid covers the formalities, and Wills in Scotland: How the Rules Differ explains where the rules differ north of the border.

A discretionary trust can be set up by signing a trust deed, which should be drawn up by someone qualified to do so, like a solicitor⁴. Trustees take on real duties. They must know what means-tested benefits and social care the disabled person receives, check the savings and income limits for means testing, communicate regularly and agree all decisions¹. Guidance for trusts set up for a disabled family member suggests choosing between two and four people as trustees to manage the money or property you are leaving³. They can be family members and friends, or professionals such as solicitors or accountants who will charge for their services³.

Where to get help, including Mencap's Wills and Trusts service

Mencap runs a Wills and Trusts service for families of people with a learning disability. It states that it covers Discretionary Trusts and Disabled Persons Trusts². It does not write wills or set up trusts, and it cannot be a trustee of a trust². What it can do is send you a list of STEP qualified legal professionals, meaning members of the Society of Trust and Estate Practitioners, when you are ready².

Separately, Mencap Trust Company is a not-for-profit trust company that manages trust funds for a person with a learning disability, and it can also act as sole trustee to your trust². That is a different role from the advice service, and worth understanding before you decide who will administer the trust.

Disability charities are clear that this is not a do-it-yourself area. Guidance from Sense states that the rules relating to disabled person's trusts and taxation are complicated, so if you are considering one, talk to a solicitor first³. Guidance on discretionary trusts makes the same point about the trust deed, which should be drawn up by someone qualified to do so⁴. If you are also thinking about how care will be paid for, Care Needs Assessments and Financial Assessments explains how the financial assessment works, and Giving Away Your Home or Money Before Care covers the rules on deprivation of assets.