Up until now it has been relatively unusual for people to use bare trusts, as discretionary trust offer the trustees significantly more control over the trust assets . However, now that a person is only allowed a lifetime limit equivalent to the Nil rate band before the total value of discretionary trusts they have settled in lifetime or on death are liable to a potential income tax charge on the 10 year anniversary bare trusts are likely to make a comeback.
This is because a gift into a bare trust is treated as a Potentially Exempt Transfer and so the gift can be unlimited and provided the settlor lives a full 7 years after the gift no IHT will be due. In addition no income tax is chargeable on the trust if the value exceed the Nil rate band on the 10 year anniversary and it does not count as part of the total amount gifted into trust. A further advantage is the trust has the full allowance benefit for capital gains tax and not half the exemption as is applied to discretionary trusts.
Bare trust s are part way between a 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. The reason bare trust 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.
Usual uses in the past
Grandparent setting aside money for grandchildren’s education is quite a common use. The CGT 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.
For the very wealthy, 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 . This enable a large gift to be made which not generating an immediate income tax charge on the trust if the gift exceeds the current Nil rate band allowance (£325,000 in tax year 2013/14).
This means the wealthy settlor can also gift £325,000 into a discretionary trust at the same time thus reducing the value of the estate after 7 years and making a large saving on Inheritance tax.
Like all inheritance tax planning it can be complex and expert advice should always be sought as mistakes can have serious financial consequences.