Parental Trusts for Minors: ‘Relevant Child’
Parents can set up a special trust for their children (under 18) as long as the child hasn’t been married or lived in a civil partnership.
Because it won’t qualify as a trust itself (per se), it is set up as (any):
- Accumulation trust
- Discretionary trust
- Interest in possession trust
Important: Another section contains detailed information on the common types of trust and how they work in Great Britain (England, Scotland, Wales) and Northern Ireland.
Who is Responsible for Paying Income Tax?
Assuming it generates a yield, the trustees will pay the Income Tax liabilities to HMRC. But, because the ‘settlor‘ is responsible for putting assets into a trust:
- The trustees would need to fill out a Trust and Estate Tax Return (form SA900) to pay any Income Tax due on the earnings. They would also need to give a statement of all income (and rates of tax charged) to the settlor.
- The final part of the process is for the ‘settlor’ to inform HM Revenue and Customs (HMRC) about the tax payments made by the trustee (e.g. the same as when you file your Self Assessment tax return online).
Qualifying as Vulnerable Beneficiaries
There are two ways to qualify as a vulnerable beneficiary for trusts. You need to be a bereaved minor under the age of eighteen (18) or a disabled person eligible for one of these qualifying benefits (even if you do not claim them):
- Armed Forces Independence Payment (AFIP)
- Attendance Allowance
- Constant Attendance Allowance (CAA)
- Child Disability Payment
- Disability Living Allowance (can be the care component at highest or middle rate, or mobility component at higher rate)
- Personal Independence Payment (PIP)
- War Pension Scheme (increased disablement pension)
Individuals who are unable to manage their own affairs due to a mental health condition might also qualify. You should contact a medical professional covered by the Mental Health Act 1983 for further details.
Special Tax Treatment for Trusts
HMRC applies special Income Tax treatment to trusts that have been set up for vulnerable people. But, tax relief does not apply to the person setting it up, if they are able to benefit from income generated by the trust.
Often, children who have lost a parent(s) will have a trust already set up via an existing ‘Will’ (or by special rules of inheritance if no will exists).
Note: In Scotland, HMRC usually treats trusts for bereaved children as ‘bare trusts‘ for taxation purposes if there is no will.
What if there are Multiple Beneficiaries?
Trusts for vulnerable people can have more than one beneficiary named in it. If so, the vulnerable beneficiaries’ assets and income must be identified and kept separate from any beneficiaries not classed as ‘vulnerable’. Thus, only this part would qualify for HMRC special tax treatment.
How to Claim the Special Tax Treatment?
Trustees would need to use ‘vulnerable person election form (VPE1)‘ to make a claim for special treatment (e.g. Income Tax, Capital Gains Tax). Use separate forms if there is more than one vulnerable person.
The trustees would need to notify HM Revenue and Customs if any of the vulnerable people are no longer classed as ‘vulnerable’, or they die.
How to Make Income Tax Deductions
Trustees get entitlement to a deduction of Income Tax when managing trusts for vulnerable beneficiaries. There are three basic steps to the calculation:
- The trustee(s) need to calculate how much their trust Income Tax would be if no claim was being made for special tax treatment. This rate varies according to the type of trust being managed.
- Next, they need to work out the amount of Income Tax the vulnerable person would have paid if they had received the earnings ‘directly’ (e.g. as the beneficiary).
- Hence, the amount the trustee(s) can claim would be the difference between the two figures, based as a deduction from their own liabilities for Income Tax.
In some cases, it can be a complex calculation to perform. But, HMRC produces detailed working examples in the Trusts, Settlements and Estates Manual.
Assets and Capital Gains Tax (CGT)
Assets held in trusts usually increase in value over time. So, selling or ‘disposing of’ (e.g. transferring ownership) trust assets can mean they become liable for Capital Gains Tax (CGT). Even so, the trustees would only pay tax if the value goes above the relevant ‘Annual Exempt Amount’.
Despite having the responsibility for paying Capital Gains Tax, the trustees can claim a reduction if the trust is for vulnerable beneficiaries, by:
- Calculating how much they would need to pay if the reduction did not apply.
- Working out what amount the beneficiary would have paid if the gains had gone ‘directly’ to them.
- Using (form SA905) to claim the difference between the two amounts based as a reduction on the amount they would need to pay in Capital Gains Tax.
Important: The special treatment used for Capital Gains Tax would not apply in the tax year if the beneficiary died.
Special Inheritance Tax Treatment
Trusts for vulnerable people qualify for special treatment relating to Inheritance Tax when it involves:
- A disabled person with a trust set up before the 8th of April 2013 (at least half of the trust payments must be paid to the disabled person during their lifetime).
- A disabled person with a trust set up since the 8th of April 2013 (all payments must go to the disabled person – excluding £3,000 maximum per year (or 3% of the assets if lower), but can be used to benefit another person).
- Someone with a health condition – that is expected to make them disabled – when they set up their own trust.
- A bereaved minor (they would need to take all the assets and income at the age of eighteen – or at some point before they reach 18).
However, the Inheritance Tax charge would not apply:
- For transfers made out of a trust that go to a vulnerable beneficiary.
- If the person setting up the trust survives for a period of seven (7) years after the date that they set it up.
HM Revenue and Customs (HMRC) treats assets held in the trust as part of the estate. Thus, they may charge Inheritance Tax when the beneficiary dies.
Important: As a rule, trusts have Inheritance Tax charges for a period of up to ten (10) years (excluding trusts with vulnerable beneficiaries).
Related Help Guides
- Trusts and Income Tax rates UK.
- Valuing an estate for Inheritance Tax.
- What are the main types of trust?
Note: The main section contains further information about how trusts and taxation works in the United Kingdom.