As a paraplanner, questions about personal injury (PI) trusts come up frequently. Although technical, they play an important role in protecting means‑tested benefits and managing compensation awards. This article 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?
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.
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.
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.
