A different kind of bequest

Special circumstances arise when someone wishes to leave significant sums of money to a vulnerable or incapacitated person. This criteria usually applies when the person lacks the mental capacity to manage their finances, whether through fluctuating mental illness, such as bipolar or schizophrenia, or more permanent disabilities such as Down's syndrome related capacity issues, or Alzheimer's.

Early considerations

There are certain considerations that need to be taken into account that are not so applicable for someone who has no disability, such as:

• Is the disability long or short-term?

• What level of decisions can they make? Is this likely to deteriorate?

• Do they have assets in their sole name already?

• Are they in receipt of means-tested benefits?

• Are there suitable family members who can act as trustees for this person once their parents/primary carers have died?

• What type of accommodation does the person live in, e.g. charity owned or at home?

There are a variety of structures which could be suited to providing for a vulnerable or incapacitated person, and a decision needs to be made as to which ones are most appropriate for the situation at hand.

Discretionary trusts

A discretionary trust (DT) has more than one beneficiary. A beneficiary's entitlement to receive a benefit from the trust fund is not fixed. Each beneficiary merely has a potential right or hope to receive a benefit, which will stand if a trustee is disabled. Trustees must take care to ensure that money from the trust fund is not spent in such a way so as to endanger any means-tested benefits received by the beneficiary.

DTs have the advantage of flexibility. Trustees have complete discretion to decide how they advance the income and capital from the trust fund and can make informed decisions to meet the vulnerable or disabled beneficiary's needs.

The settlor of the trust can also prepare a letter of wishes to sit with the DT, setting out their reasons for setting up the trust and providing guidance on how the trust should be used for the benefit of the disabled beneficiary (and other beneficiaries). There are tax consequences, however.

DTs are useful in most situations, particularly where, for example, parents leave a portion of their estate through their wills to a mentally disabled child, perhaps with other close siblings acting as trustees of the trust and managing the trust for the benefit of the family in general, but with special considerations for the disabled sibling.

Disabled persons trust

Strict conditions must be met in order for a trust to qualify as a disabled persons trust (DPT). The trust must be set up for the benefit of a disabled person. A 'disabled person' is defined as an individual unable to administer their property and financial affairs because of a mental disorder, or a person in receipt of, or entitled to be in receipt of, attendance allowance or disability allowance.

Trustees of the DPT must ensure that at least half of any capital payments made out of the trust fund, and any income derived from the trust fund, must be paid to or be used for the benefit of the disabled person.

Trustees have very wide powers to meet any needs the disabled person may have during their lifetime, even extending to the power to pay charities supporting the disabled beneficiary in some way. If the conditions are satisfied, DPTs qualify for favourable tax treatment.

DPTs are useful in situations where a donor wishes to leave the disabled person a substantial absolute gift in their lifetime, and that disabled person lives in special accommodation run by a charity, who can benefit from the fund on the main beneficiary's death.

Protective trusts

Protective trusts (PT) are an effective tool to use if clients wish to protect the income as well as the capital of the trust, from a beneficiary's reckless or immature acts. They have recently decreased in popularity, however, in some circumstances, they are worth considering in relation to gifts to vulnerable people. To create a PT, the beneficiary would receive a life interest in the trust fund.

The remainder would be held on trust for a wider class of beneficiaries. The class of beneficiaries usually includes the family of the life interest beneficiary. The life interest is protected and would automatically convert to a DT if the life interest beneficiary commits a divesting act, for example, went bankrupt.

A will trust or a pilot trust?

Any of the trusts described can be created in a client's will. However some clients prefer to create a pilot trust (like a shell of a trust with only a small amount settled in it) and then leave a portion of their estates to that pilot trust through their wills.

Pilot trusts allow for anyone, including other relatives who may wish to leave assets to those vulnerable or disabled family members in their wills, to add to the trust fund by leaving gifts to the trust.

It can be a way for a variety of family members and friends to make gifts to a disabled beneficiary, without it affecting their means-tested benefits.

A very common pitfall

If a couple have a mentally disabled child, it is not uncommon for them to open a bank account for the child and put all of their savings into that bank account, sometimes also transferring the house to their child.

If handled incorrectly, this can have severe consequences for the parents in their later years. If one of the parents should pass away, for example, and the surviving spouse needs care, they could find themselves in the following unusual position:

1. The child is the significantly wealthier one of the two of them, but cannot make any decisions regarding their finances, does not have an attorney under a lasting power of attorney, nor has a court appointed deputy. It is also likely that if the child is to make any gifts to the surviving parent, it would need to be ratified by the Court of Protection.

2. The elderly parent has no assets with which to pay for their own care, and now finds themselves financially dependent on a mentally incapable person.

3. The child has not been receiving the state benefits which they should have been entitled to all their lives.

This difficult situation can all be avoided if proper advice is taken at an early stage and the correct structure is set up.

Another concept that people attempt without taking advice is to leave an outright gift to another family member, with an informal understanding that they will provide for their disabled family member. At first glance, this may seem like a viable, albeit informal, solution for clients. However, this option is not without substantial risk. At best, it may lead to uncertainty for the disabled family member and, at worst, could lead to family friction and bitterly contested inheritance disputes.

Such informal arrangements may lead to a claim against the testator's estate by the local authority responsible for caring for the disabled family member, on the grounds the testator should have made provisions to provide for the disabled family member, as a dependant of the testator.

Defending inheritance claims can be costly, and legal fees would inevitably reduce the size of the estate passing to beneficiaries.

Placing assets in trust for the benefit of a vulnerable or disabled person is a valuable solution, with charities and professionals alike advocating the benefit of trusts as a financial management tool.

When deciding what type of trust to create, it is imperative that the individual circumstances of the vulnerable or disabled person and the family set-up be considered. There is no 'one size fits all' solution.

Helen Freely is a partner at Druces and Katie Underhill is a trainee at the firm