Personal Injury Compensation and IHT: The s5(2) Exclusion and Personal Injury Trusts
Under IHTA 1984 s5(2), personal injury compensation held in a personal injury trust (PIT) is excluded from the claimant's taxable estate for IHT. Without the trust, a large damages award could push the claimant's estate above the nil-rate band, resulting in a significant IHT bill on death. The PIT also protects compensation from means-testing for social care and means-tested benefits.
Benefits of a Personal Injury Trust
IHT exclusion under IHTA 1984 s5(2)
Compensation held in a PIT is excluded from the disabled person's estate for IHT. Without this exclusion, a £1m damages award would add £1m to the taxable estate — potentially creating a £400,000 IHT liability on death.
Means-testing protection for social care
Under the Care Act 2014 (England), a local authority must disregard personal injury compensation held in a personal injury trust when assessing the claimant's means for care funding. Without a trust, the compensation is counted as capital and the claimant pays for their own care until the compensation is spent.
Benefits protection
Personal injury compensation in a PIT is disregarded for most means-tested benefits assessments (ESA, Universal Credit, Housing Benefit). Without the trust, a claimant who received compensation above £16,000 would typically lose means-tested benefits.
Managed access to funds
The trustees (who may include the claimant, a family member, and a professional trustee) manage how the trust funds are applied for the claimant's benefit. Funds can be released to the claimant as needed, while the trust structure maintains the tax and benefit protections.
Court of Protection compatibility
Where the injured person lacks mental capacity, the compensation may be managed by the Court of Protection. A personal injury trust is compatible with Court of Protection oversight — and in practice, a deputyship is often combined with a personal injury trust structure.
Frequently Asked Questions
What is the IHTA 1984 s5(2) exclusion for personal injury compensation?
Under IHTA 1984 s5(2), for the purpose of calculating a person's estate, the definition of 'property' does not include property that is given by way of compensation or damages for any wrong or injury suffered by the property recipient. This means compensation received for personal injury — whether from a court award, structured settlement, or out-of-court settlement — is not 'property' for IHT purposes if it is held in an appropriate personal injury trust (PIT). The compensation itself, as long as it remains in the trust and is attributable to the personal injury, does not form part of the recipient's taxable estate. This exclusion is narrow: it applies only to compensation for personal injury, not to general inheritance or savings. If the compensation is paid directly to the claimant and held in their personal bank account, HMRC takes the view that it has been mixed with the claimant's general assets and is no longer identifiable as personal injury compensation — meaning the s5(2) exclusion may be lost. Maintaining separate accounts and the trust structure is therefore essential.
What is a personal injury trust and who should be the trustees?
A personal injury trust (PIT) is a trust specifically designed to hold personal injury compensation while preserving the tax and benefit protections available to the injured claimant. The trust document (usually a simple bare trust or an interest in possession trust) identifies the claimant as the sole beneficiary with the absolute right to the trust funds. Trustees are typically: (1) the claimant themselves (if they have mental capacity); (2) a family member (spouse, parent, adult child); and (3) optionally, a professional trustee (e.g. a solicitor). A minimum of two trustees is recommended to satisfy the formal requirements for trust operation. The trustees hold the compensation funds in a separate bank account in the trust name, make payments to or for the benefit of the claimant as needed, and keep basic trust accounts. The claimant can access their funds through the trustees at any time — the PIT is not designed to restrict access, only to protect the tax and benefit status of the compensation.
Does personal injury compensation in a trust count as part of the estate for IHT?
No — provided the compensation is held in a properly constituted personal injury trust and remains attributable to the personal injury award. The exclusion under IHTA 1984 s5(2) removes the compensation from the estate calculation. In practice: a claimant who receives £800,000 in personal injury damages and places the full amount into a PIT will have their IHT estate calculated without those funds. If the claimant's other assets are below the nil-rate band (£325,000), no IHT will be due on their death. The compensation passes to the claimant's beneficiaries (as named in the trust deed or, on the claimant's death, to their estate) without IHT on the trust funds. Key conditions for s5(2) to apply: (1) the payment must be compensation or damages for a wrong or injury; (2) the payment must be to the person who suffered the wrong or injury; (3) the payment must be held in a separately identifiable form (not mixed with general personal savings). HMRC's Inheritance Tax Manual at IHTM04253 confirms the exclusion and its conditions.
What happens to a personal injury trust on the claimant's death?
On the death of the claimant, the personal injury trust typically terminates (most PITs are structured as absolute/bare trusts where the beneficiary is the claimant with full beneficial entitlement). The trust funds pass to the claimant's estate and are distributed under their will or intestacy rules. Crucially: the s5(2) IHT exclusion applies only to the claimant during their lifetime. On the claimant's death, the compensation in the trust forms part of their estate in the normal way — and is subject to IHT if the estate exceeds the nil-rate band. The IHT benefit of the PIT is that the compensation was excluded from the claimant's estate during their lifetime, not that it is permanently exempt from IHT in perpetuity. For claimants with large compensation awards, this means the claimant may wish to make lifetime gifts from the trust, use the annual exemption, or make charitable legacies in their will to mitigate the IHT on eventual death. A well-drafted will is therefore important to maximise the available IHT allowances on second death.
Can a personal injury trust be set up after the compensation has already been paid?
Yes — a personal injury trust can be set up after the compensation has been received, but it should be done as promptly as possible after payment. The longer the compensation sits in the claimant's personal account before being transferred to the trust, the greater the risk that HMRC (or the DWP for benefits purposes) takes the view that it has been mixed with general savings and is no longer separately identifiable as personal injury compensation. Practically, the PIT deed should be signed and the trust bank account opened as soon as the compensation is received or shortly afterwards. Where the compensation was received some time ago without a trust being established, specialist legal advice is needed — HMRC guidance (IHTM04253) acknowledges that belated transfers are possible, but care is needed to ensure the funds transferred can still be clearly attributed to the original personal injury award. Any interest or investment growth on the compensation while it was in the claimant's personal account is not personal injury compensation — it is the claimant's own income and remains in the taxable estate.
Does the personal injury trust exemption apply to structured settlements?
Yes — periodic payments (structured settlements) received under a structured settlement arrangement are also excluded under IHTA 1984 s5(2) provided they are compensation for personal injury. A structured settlement pays regular instalments to the claimant over their lifetime rather than a lump sum. Each payment is compensation for the injury. Since structured settlements are paid periodically, the recipient receives smaller amounts at a time — and typically spends them on care, living expenses, and other needs. As each payment is spent on the claimant's needs, it does not accumulate in the estate in the same way that a lump sum might. However, if the claimant accumulates unspent structured settlement payments in a bank account, those accumulated funds may over time be regarded as the claimant's own savings rather than personal injury compensation — potentially losing the s5(2) exclusion. Placing accumulated payments into a PIT as they are received maintains the exclusion.
Update Your Will to Reflect a PIT
A personal injury trust should be co-ordinated with your will. Your will needs to address what happens to the trust funds on your death and ensure your executors understand the trust structure. WillSafe UK provides plain-English will kits for England and Wales.
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