Personal injury trusts: benefits and PITfalls

As reported in the Scotsman last June, the NHS in Scotland paid almost £50 million in compensation payments in 2009-10. Large individual payments tend to involve obstetric and midwifery negligence claims, and other instances of medical negligence, often necessitating high levels of care for the rest of a claimant’s life. In such cases, and in other instances of accidental, negligent or criminal injury, whether physical or mental, consideration should be given to setting up a personal injury trust (“PIT”).

PITs seem to be the subject of many myths and misconceptions. The term “personal injury trust” is simply a tag and is not statutorily defined. Although many forms of trust can be used – bare, liferent, discretionary, or trusts for disabled persons – whatever the legal type of trust, if it is funded by an award of compensation for a personal injury, it can be described as a PIT.

Why set up a PIT?

There are many good reasons to place an award in trust. Commonly, these include protection of funds from undue influence, financial inexperience or matrimonial or relationship problems. Many claimants will be vulnerable and, if they lack legal capacity, the advantages of setting up a trust are obvious.

A compelling advantage accorded to PITs is the disregard from means testing by the Benefits Agency. By placing the compensation sum in a trust, eligibility for income support, housing benefit and ancillary benefits such as free prescriptions can be preserved. This is more of a concern than ever, given the drastic cuts and reforms being made to the benefits system. Trusts can also be very helpful in preserving funds against the costs of long-term care.

Which forms of trust should be used?

This will depend on the claimant’s personal and family circumstances. The tax treatment will be important, especially in awards larger than the inheritance tax nil rate band (presently £325,000).

In England & Wales, bare trusts appear to be the only option where a child obtains damages. There is also a set procedure for application to the Court of Protection to establish a personal injury bare trust for an adult who lacks mental capacity. The excellent Coldrick, Personal Injury Trusts (4th ed), the leading English publication in this field, will not give the Scottish practitioner the full picture, owing to the substantive legal differences between the jurisdictions.

A bare trust will be the basic option. It should preserve eligibility to means-tested benefits, but does not otherwise offer much protection of the trust funds.

Liferent trusts are rather undesirable, given the need for the trustees to balance the interests of liferenter and fiars (although a flexible liferent trust could be less restrictive).

For the greatest flexibility, discretionary trusts are likely to be a good choice. If the claimant is eligible, it may be possible to set up a “trust for a disabled person”. Under s 89(4) of the Inheritance Tax Act 1984, a “disabled person” is defined as a person who is:

• incapable, by reason of mental disorder within the meaning of the Mental Health Act 1983 (the English statute applies) of administering his property or managing his affairs, or
• in receipt of an attendance allowance, or
• in receipt of a disability living allowance by virtue of entitlement to the care component at the highest or middle rate.

The disabled person must qualify at the date when the property is settled. From 2013-14, all new and existing claimants of DLA will be subject to a medical assessment. The level of the benefit will not be reduced, but the Government has estimated the move will save £1.4bn by 2015. Individuals who are eligible for DLA today may not be eligible for DLA in the near future.

Precise drafting will be required so that the trust falls outside the IHT relevant property regime. Under s 89(1), the terms of the trust must provide that:

• during the life of the disabled beneficiary, no interest in possession in the settled property subsists, and
• not less than half of the settled property which is applied during their life is applied for their benefit.

The major advantage of establishing a trust for a disabled person is that there is no lifetime 20% charge to inheritance tax for settlements over the nil rate band, and there are no periodic or exit charges. For a large settlement which is expected to remain in place for a long time, these savings may be substantial (particularly if the trustees also make tax efficient investment choices).

As with all trusts, the tax implications of establishing and running a PIT should be considered when advising on the best option for the claimant. Most importantly, the trust should give the trustees sufficient flexibility to assist the beneficiary in whatever ways are likely to be necessary.

Categories of claimant

Claimants fall into three categories:

• children
• capable adults
• incapable adults.

In each category there will be different considerations over matters such as who settles the fund, who the trustees should be, and the class of beneficiaries. Perhaps the most difficult issues arise in cases concerning children.

Child beneficiaries

PITs can be settled by parents, as a child’s legal representatives. Under s 10(1)(b) of the Children (Scotland) Act 1995, the parent “shall be entitled to do anything which the child, if of full age and capacity, could do in relation to [the child’s] property”.

Parents will be settlors of the trust as legal representatives of the child, rather than as parents of the child. This distinction can be important, as it allows the parents to be potential beneficiaries, without the income and gains of the PIT being attributed to them for tax purposes.

Parents will often be trustees. It seems that, where asked, the Accountant of Court would offer the suggestion that, in order to provide some protective safeguard for the child’s funds, one of the trustees of the trust should be a professional. If the trustees are the two parents and an independent professional trustee, as a matter of trust law, this places the sole professional trustee in the minority. So, providing that one trustee should always be an independent professional may not be a sufficient safeguard.

PITs for children offer a great degree of protection and control, but a control that can be independent of the Accountant of Court and Office of the Public Guardian.

The costs of trust administration may not be significantly different from the equivalent cost of administering a financial guardianship, which otherwise would be required once a mentally incapable child attains the age of 16.

Parents as potential beneficiaries

It could be seen as unduly aggressive for the parents to be specifically named in the class of potential beneficiaries determined for the trust. This class would normally include the injured child, any siblings and possibly the other issue of the parents. There may be a power to add beneficiaries and a long-stop provision, perhaps in favour of a charity. An alternative might be to include as potential members of the class the injured person’s heirs on intestacy, which would be likely to include the parents.

The inclusion of parents as beneficiaries may be of particular relevance if the trustees may wish to purchase a family home, where the parents will reside with the injured child. The potential for conflicts of interest here is obvious. The parents may be concerned about security of tenure (particularly if their child is likely to attain some level of independence as an adult).

Options to consider include joint ownership of the property, tenancies, or even the use of separate sub-trusts. The preservation of principal private residence relief for CGT will be important.

Capable adults

Perhaps the biggest decision to be made in relation to capable adults is whether or not the injured claimant should act as a trustee of their own trust. If they are, it would be essential to provide that there should always be at least one other trustee.

Incapable adults

If the claimant lacks capacity, matters fall within the remit of the Office of the Public Guardian. It seems that the OPG, and indeed some sheriffs, may not consider that it is in the best interests of an adult to allow the setting up of a PIT. Arguably, it might infringe the concept of minimum intervention enshrined in the Adults with Incapacity (Scotland) Act 2000. It seems that PITs will be permitted only in exceptional circumstances and where they can clearly be demonstrated to be of benefit to the adult.

Even where a trust is in place, it may still be necessary to run a parallel financial guardianship to cover the adult’s personal estate. In practical terms, there may be little difference between operating a guardianship as opposed to a trust. However, there will be cases where the benefits and taxation advantages of a trust make it the more attractive option.

Interactions

Every claimant’s needs and expectations will be different. However, it is submitted that, in the case of any significant personal injury compensation award, consideration ought to be given to, and advice obtained on, the possible use of a PIT – and preferably long before the award, or interim award, is in the claimant’s hands. Always bear in mind that there are complex interactions of trust law, taxation and benefits to think about.