Using a Bare Trust to Avoid Inheritance Tax

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Up until now, it has been relatively unusual for people to use Bare Trusts, as discretionary trust offers the trustees significantly more control over the trust assets.

However, Bare Trusts are likely to make a comeback as the total value of Discretionary Trusts settled in a lifetime or on death is liable to a potential income tax charge on the tenth anniversary.

The main reason for the possible income tax charge with a Discretionary Trust is that the trust is only allowed a lifetime limit equivalent to the Nil Rate Band.  However, a gift into a Bare Trust is treated as a Potentially Exempt Transfer and so is essentially unlimited in the value that can be placed into it.

What is a Potentially Exempt Transfer?

Potentially Exempt transfer means the gift is still potentially liable to Inheritance Tax unless the person making the gift lives 7 years from the date of the gift. The amount of the gift can be unlimited and provided the settlor lives a full seven years after the gift no IHT will be due.

Further Advantage of the Bare Trust

A further advantage is that the trust has the full allowance benefit for Capital Gains Tax and not half the exemption as is applied to Discretionary Trusts.

Bare Trusts are partway between full trust and outright ownership.

The trustees have the usual trustee responsibilities, but for tax, the liability arises on the beneficiaries and not the trustees.

Why are Bare Trusts not used as much as Discretionary Trusts?

The reason Bare Trusts are not used often is that once the beneficiaries have reached 18 years of age, they can demand the transfer of all the capital. Also, if the beneficiary dies, the assets form part of their estate for IHT purposes. This is not the case in Discretionary Trusts as distributions from the trusts are entirely at the discretion of the trustees.

Usual uses of Bare Trusts in the past

A grandparent setting aside money for grandchildren’s education is quite a common use. The Capital Gains Tax arising on the beneficiaries is advantageous, and the grandparents may also want to use their full discretionary allowance for other purposes like Inheritance Tax planning.

The present uses of Bare Trusts 

For people with significant capital, gifts may want to be made into a discounted gift trust using a Bare Trust arrangement which retains the right for up to 5% return of capital tax-free yearly to the settlors and cannot be wound up by the beneficiaries during the life of the settlor.

Large gifts using Bare and Discretionary Trusts

Using a Bare Trust enables a large gift to be made which will not generate an immediate income tax charge on the trust if the gift exceeds the current Nil rate band allowance (£325,000 in tax year 2019/20).

The settlor can also gift £325,000 into a Discretionary Trust at the same time, thus reducing the value of the estate after seven years and making a significant saving on Inheritance Tax.

As always experienced advice is important in this field. Contact us if you require help in this area.