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For many years the UK has had a benefits system that includes non means tested benefits for people with disabilities to recognise the additional costs that they face. Disability Living Allowance (DLA) for adults in England and Wales was replaced by PIP – the Personal Independence Payment in 2013, and there are currently more than 3.3 million people receiving this benefit, with the numbers increasing monthly. The prime minister has announced a consultation around disability benefits, and potentially reforming these, which could have knock on consequences.

Back in 2005, a special type of trust was introduced for vulnerable beneficiaries, where the tax treatment may be more favourable than for a typical trust. The legislation sets out the definition of a 'disabled person' – this includes those who have a mental health condition covered by the Mental Health Act, as well as those receiving certain state benefits, including PIP, DLA (for children) or their Scottish equivalents, the Adult and Child Disability payments; as well as attendance allowance for those over state pension age.

If the individual is eligible for one of these benefits then a vulnerable beneficiary trust can be set up for them. Whilst a claim for this treatment is needed each year, and there is a complex calculation needed, broadly the trustees pay income tax and capital gains tax as if the beneficiary had received the income and realised any capital gains directly.

For inheritance tax (IHT) purposes, a transfer into a vulnerable beneficiary’s trust is treated as if the gift was made directly to the beneficiary – there is no IHT on a lifetime transfer into such a trust (unless the person setting up the trust dies within 7 years), there is no 10 year anniversary charge and there is no IHT on transfer of assets out of the trust to the beneficiary. There is, however, potentially IHT due on the death of the beneficiary, as the assets will form part of their estate as if they were directly held.

These special trusts are really valuable to families where an outright gift may not be appropriate, as this can provide legal protection preventing assets being sold or further gifted, but still generate an income for the benefit of the beneficiary in a broadly tax neutral way. This gives the best of both worlds – legal protection and no punitive tax treatment.

The question would be though, whether by reforming the disability benefit system, there could be an unintended consequence of impacting these trusts put in place to protect some of the most vulnerable in society.