In our experience the use and choice of trusts can feel overwhelming, therefore this article will look at what a Bare Trust is and how this type of trust can be used to pass on wealth to different individuals.
What is a Bare Trust?
A Bare Trust (sometimes known as an absolute or fixed interest trust) is the simplest form of trust, that enables you to transfer assets to a small group of people.
How do Bare Trusts work?
When you create a Bare Trust you name a specific beneficiary/ies who then have an absolute right to both the income (usually interest) and the capital from the trust. They are usually used for minor children who do not have capacity to take legal title themselves.
Generally, any child who is under the age of 18 years (in England and Wales) or 16 (in Scotland) would be classed as a minor beneficiary. The trustees you have appointed are simply looking after the trust assets until your child is old enough to take ownership.
Bare Trusts are most commonly used to make a gift to a child, but anyone can be named as a beneficiary of a Bare Trust. However, once they have been named, neither you nor your appointed trustees can change who is entitled to the assets.
Does the trust automatically end when a child reaches their majority?
Although a beneficiary of a Bare Trust gains control of the trust assets when they reach 18 (16 in Scotland) the Bare Trust does not automatically end. Where the beneficiary is an adult, the trustee position is more like a nominee and they must follow the directions of the beneficiary in relation to the assets held.
Setting up a Bare Trust
Bare Trusts are less complex than Discretionary Trusts to set up. Nevertheless, it is strongly recommended that you seek professional advice first, as the lack of flexibility of a Bare Trust means it is essential that you fully understand the additional implications before going down this route (e.g. the obligations of the trustees when the beneficiary turns age 18).
We have a number of dependable legal contacts who we work alongside to ensure that any future planning is undertaken on a joined-up basis, whilst fully reflecting your wishes.
What are the benefits of a Bare Trust?
Bare Trusts are often used by grandparents that want to start building a nest egg for their grandchildren and do not want them to have access to the money until they reach their majority. They are also useful from a taxation perspective. Your initial gift into a Bare Trust arrangement is a potentially exempt transfer (unless covered by an exemption) and providing you survive seven years there is no charge to inheritance tax1.
If the beneficiary has no other taxable income, as is generally the case for a minor child, they would have their full tax allowances available to offset against any income or capital gains tax arising from the trust assets. There are no ongoing inheritance tax implications for a Bare Trust.
Please note: HMRC have parental settlement rules, so where a trust is set up by a parent for their minor unmarried child(ren), income tax will continue to be assessed against the parent/s where the income exceeds £100 pa (£200 pa if a joint gift).
What are the drawbacks of a Bare Trust?
While a Bare Trust is a very simple form of trust, it does have its drawbacks. The main disadvantage is that they have a rigid structure meaning that the named beneficiaries cannot be changed once the trust has been established. This could cause issues should any other children or grandchildren be born following creation of the trust as they, unfairly, cannot benefit from the trust assets.
Furthermore, the trust beneficiaries have the right to take possession of the trust assets at the age of 18 and deal with them as they see fit. Some parents/grandparents worry that this will result in the assets being sold and the proceeds wasted.
Additionally, you can set up a Bare Trust without telling the beneficiaries and although this may be a benefit initially, could cause complications if any of the beneficiaries has a significant income or capital gains tax liability. Nonetheless, the trustees must inform the beneficiaries of the trust's existence upon reaching age 18, known as the age of majority, which may still leave the trust assets in the potentially not-so-safe hands of teenagers.
Typically, however, the trust can be set up for funding education costs and paid directly from the trust. This then makes it possible to calculate the amount needed for this purpose, thereby leaving a smaller, less problematic sum of money left for the beneficiaries to enjoy.
Is a Bare Trust right for me?
If you want to establish a trust for a specific individual and are happy for them to have full control of the assets once they reach adulthood then a Bare Trust can be a more tax efficient solution on an ongoing basis than most other types of trust available in the UK.
There are alternative trust arrangements which allow greater flexibility or discretion over potential beneficiaries and which allow the trustees to have greater control over the distribution of assets. However, these trusts would be treated very differently for tax purposes and require a much greater level of administration.
How can we help?
With so many different types of trust arrangements in existence, it can be extremely challenging to decide if a trust is the best solution for you, or equally, which trust would be most suitable given your requirements. We have decades of experience in helping people choose the right arrangement for passing on wealth and are here to help.
If you would like to find out more about whether trusts are the right solution for you, please do not hesitate to contact us.
Please Note: that the FCA does not regulate tax and trust advice.
1. The ongoing tax treatment of a Bare Trust can be beneficial as any income or capital gains are assessed against the beneficiary.