A bare trust is one of the simplest forms of trust, and that simplicity brings some advantages.
For example, compared to a discretionary trust, a bare trust is relatively straightforward to administer, which helps to reduce the running costs. In addition, overall tax charges on a bare trust are usually lower than on other types of trust.
What is a Bare Trust?
A bare trust is a simple, legal document that anyone can set up. Assets (e.g. investments) are held by a trustee (often a parent or grandparent) for the benefit of a beneficiary (usually a child). There is no limit on what or how much can be put into a bare trust. A bare trust is, in a way, a halfway house between a full trust and outright ownership.
One of the most common uses for bare trusts is where grandparents want to set aside funds for their grandchildren’s education. If the funds are given away early and the grandparents survive seven years, then this gift will be outside the inheritance tax charge on their deaths.
Be aware of the drawbacks
The simplicity of a bare trust does have its disadvantages – one of which is the relative lack of control for the trustees.
A beneficiary of a bare trust is entitled to take control of the trust assets (or their share of them) at 18. Many 18-year olds are happy to leave the assets with the trustees and follow their advice on how best to use the income and capital. But that’s not always the case. The trustees may worry the money may be used irresponsibly, yet as long as the beneficiary has reached 18 and has mental capacity, the trustees must hand over the assets if the beneficiary asks for them.
Trustees can delay the beneficiary’s capital entitlement, for example if the beneficiary was terminally ill. But these powers can only be used in exceptional circumstances. They’re not something you should rely on if you’re seriously concerned about what will happen when a beneficiary becomes entitled to capital at 18.
Potential inheritance tax penalties
A bare trust holding very valuable assets isn’t a good choice for a child with limited life expectancy. The value of the trust assets is included in their estate, so if the child dies young and is intestate (which is most likely), there’s the potential for a substantial inheritance tax charge.
Can I create a bare trust for more than one person?
Yes – as long as each beneficiary is absolutely entitled to their share of the trust’s assets. Trustees must not change the shares or use the income from one beneficiary’s share to benefit another.
What does a bare trust for a child involve?
A bare trust for a child under 18 is a trust established for the benefit of someone whose beneficial ownership of the trust assets is absolute (or unimpaired). Although it’s called a bare trust, it still means work for you as a trustee. For example, you have a duty to invest trust assets, and consider whether and how to use the trust’s income and capital for the beneficiary.
How are bare trusts taxed?
- Income tax. The income is usually taxed as if the beneficiary received it directly and at the beneficiary’s rates. If the beneficiary is your child or step-child, any trust income over £100 is taxed as your income while your child is under 18. In this case, it’s preferable for grandparents to make the gift to the trust. Alternatively, you could set up a bare trust holding assets that produce little or no income.
- Capital gains tax (CGT). If you transfer assets during your lifetime to a bare trust whose market value exceeds the acquisition cost, CGT is charged on the notional gain. Gains realised by the trustees are treated as realised by the beneficiary and their annual exempt amount is available to offset the gains.
- Inheritance tax (IHT). The assets are in the beneficiary’s estate and will be subject to IHT on their death. If you make a gift to a bare trust, you need to survive for seven years for the value of the gift to fall outside your estate for IHT purposes.