As a paraplanner, questions about personal injury (PI) trusts can come up from time to time. Although technical, they play an important role in protecting means‑tested benefits and managing compensation awards. This article from Quilter, aims to demystify personal injury trusts, so you can confidently advise both clients and advisers alike.
What is a Personal Injury (PI) Trust?
A PI trust is not a distinct legal type of trust but a trust created to hold funds from a personal injury award. It can take the form of an absolute, discretionary, or interest in possession (IIP) trust, provided the settlement funds arise directly from:
- Accidents caused by another party’s negligence
- Medical negligence
- Criminal acts by another party
- Charitable payments, insurance claims or government compensation schemes linked to the injury
Awards may be court‑ordered or agreed settlements. Regardless, the injured person is usually deemed to be the settlor of the trust.
Why use a Personal Injury Trust?
Protection of means‑tested benefits
The primary reason is that capital and income within a PI trust are disregarded for means‑tested benefits, including state benefits and local authority care funding. Normally, transferring assets into trust would count as deliberate deprivation, but PI trusts are exempt.
To qualify, the compensation must be placed in trust within 52 weeks of receipt. Where payments are given in instalments, the 52‑week period begins on the first payment. Payments received after 52 weeks are not disregarded and must be kept separate.
Structure and control
The settlor can choose trustees and beneficiaries and may also act as a trustee, giving them direct control. Trustees may use the fund for the injured person’s needs, such as living costs, equipment, home improvements and holidays.
Setting up a Personal Injury Trust
PI trusts are typically created by a solicitor acting for the injured person. Whilst it is possible to use an ‘off the shelf’ solution, such as Quilter’s range of trusts, legal advice is recommended.
Loss of mental capacity
For individuals lacking capacity (for example, due to brain injury), the Court of Protection determines how the award should be managed. A court‑appointed deputy often replaces the need for a trust as funds managed by a deputy are also disregarded for means‑testing.
Minor children
Courts must approve PI trusts created for minors. The Court of Protection may again be considered more suitable.
Choice of trust type
Although most PI trusts are absolute trusts with the injured person as sole beneficiary, a discretionary or interest in possession (IIP) trust can be used if the injured person is included as a beneficiary.
- Discretionary trust: trustees decide how and when funds are distributed.
- IIP trust: the injured person usually receives income for life (known as the life tenant), with capital passing to other beneficiaries (remainder) on death.
These structures can provide benefits compared to an absolute trust – such as:
- Succession planning – assets can continue for other beneficiaries rather than passing under the injured person’s will.
- Protection of capital – the beneficiary cannot demand capital outright, which is useful if they struggle to manage money.
Tax treatment
Absolute Trust
Inheritance Tax (IHT):
Where the injured person is the sole beneficiary, no transfer of value occurs and therefore no lifetime gift is made. The trust’s value is included in their estate on death and distributed under their Will or intestacy.
Income Tax and Capital Gains Tax (CGT):
Income and gains are taxed on the beneficiary at their marginal rate, and they retain full personal allowances and exemptions.
Discretionary and Interest in Possession Trusts
IHT:
Gifts to these trusts are generally chargeable lifetime transfers (CLTs). Where cumulative CLTs in seven years exceed the £325,000 nNil rate band (NRB) a 20% entry charge applies.
If the injured person meets the statutory definition of a disabled person (Finance Act 2005, Sch 1A), the transfer becomes a potentially exempt transfer (PET) instead, avoiding the entry charge. Restrictions apply: payments to other beneficiaries are limited to 3% of the fund per year or £3,000 (whichever is lower).
Regardless of initial treatment, if the injured person remains a beneficiary, the gift with reservation rules apply, meaning the trust’s value is included in their estate for IHT.
Discretionary and IIP trusts may also face periodic (10‑year) and exit charges, unless the disabled‑beneficiary rules apply.
Income Tax and CGT:
- Discretionary trusts: Settlor‑interested rules apply (the injured person is both settlor and potential beneficiary), so income is taxed at the settlor’s marginal rate.
- IIP trusts: Income is taxed on the life tenant at their marginal rate.
CGT: Trusts pay CGT at 24%, with an annual exemption of up to £1,500 (depending on the number of settlements created). Where the injured person qualifies as a vulnerable beneficiary, CGT relief may reduce tax to what the beneficiary personally would have paid.
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