• any capital leaving the trust must be used for the benefit of the disabled person; and
• the disabled person must either be entitled to all the income outright, or, if the trustees have the discretion as to if and when the income is paid out, then any payments made must be used to benefit the disabled person during their lifetime.

Once these conditions have been met, then the trust will be treated more favourably than normal trusts in respect of income tax, CGT and IHT.

If there is more than one beneficiary and some are not vulnerable, the assets and income for the vulnerable beneficiary must be identified and kept separate, and used only for that person.

Only that part of the trust gets special tax treatment.

Claiming special tax treatment

To claim special treatment for income tax and CGT, the trustees must fill in a vulnerable person election form. If there is more than one vulnerable beneficiary, each needs a separate form.

The trustees and beneficiary must both sign the form. If the vulnerable person dies or is no longer vulnerable, the trustees must inform HMRC.

In a trust with a vulnerable beneficiary, the trustees are entitled to a deduction of income tax. It is calculated in three stages:

1. Trustees work out what their trust income tax would be if there was no claim for special treatment – this will vary according to the type of trust.
2. They then work out what income tax the vulnerable person would have paid if the trust income had been paid directly to them as an individual.
3. They can then claim the difference between these two figures as a deduction from their own income tax liability.

CGT may be due if assets are sold, given away, exchanged or transferred in another way and they have gone up in value since being put into trust.

Tax is only paid by trustees if the assets have increased in value above the trust’s tax-free allowance (called the annual exempt amount).

For the 2023-24 tax year, the tax-free allowance for trusts is £6,000 for vulnerable beneficiaries and £3,000 for other trustees.

Trustees are responsible for paying any CGT due. If the trust is for vulnerable people, trustees can claim a reduction, which is calculated in three steps:

1. They work out what they would pay if there was no reduction.
2. They then work out what the beneficiary would have to pay if the gains had come directly to them.
3. They can claim the difference between these two amounts as a reduction on what they must pay in CGT using form SA905.

This special CGT treatment does not apply in the tax year when the beneficiary dies.

These are the situations when trusts for vulnerable people get special IHT treatment:

• For a disabled person whose trust was set up before April 8 2013 – at least half of the payments from the trust must go to the disabled person during their lifetime.
• For a disabled person whose trust was set up on or after April 8 2013 – all payments must go to the disabled person, except for up to £3,000 per year (or 3 per cent of the assets, if that is lower), which can be used for someone else’s benefit.
• When someone who has a condition that is expected to make them disabled sets up a trust for themselves.

There is no IHT charge on the settlor if the person who set up the trust survives seven years from the date they set it up, or on transfers made from a trust to a vulnerable beneficiary.

When the beneficiary dies, any assets held in the trust on their behalf are treated as part of their estate and IHT may be charged.

Trusts usually have 10-year IHT charges, but trusts with vulnerable beneficiaries are exempt.

Gaining an understanding of the basics of vulnerable person trusts and the different state benefits available enables you to talk confidently with clients with disabled dependents.

Understanding their taxation enables you to help trustees manage the investments within the trust.

Richard Cooper is business development manager at the London Institute of Banking & Finance