Setting Up Bare Trust in the UK
A bare trust is a simple legal structure where assets are held by trustees until the beneficiaries turn 18 and get full control. It’s popular for its ease of management and tax benefits, though it’s important to consider potential capital gains taxes depending on the jurisdiction. In this article we’ll look at how bare trusts work, the features and the tax implications.
Key Points
- Beneficiaries get control of assets immediately when they turn 18, a simple way to transfer wealth.
- Income earned in a bare trust is taxed as the beneficiary’s, so minors can have low tax liability due to their tax free allowances.
- Bare trusts can accommodate more than one beneficiary, making them suitable for families or defined groups, allowing multiple beneficiaries to benefit from the trust.
- Bare trusts are flexible and tax efficient but have limitations, including irrevocable beneficiary nominations and young beneficiaries having control of large sums at 18.
What are Bare Trusts
Bare trusts, also known as simple, are simple structures to hold assets for beneficiaries who get control immediately when they turn 18. Unlike discretionary trusts where trustees have the power to decide how to distribute the assets, bare trusts give the beneficiaries an absolute right to the capital and income of the trust, often managed through a bare trust account.
Trustees manage the assets in a bare trust, hold them until the beneficiary turns a certain age, usually 18 in the UK. The settlor nominates the beneficiaries and this cannot be changed, so all parties have certainty and clarity. Parental settlement rules apply to trusts created by parents for their minor children, meaning that income generated from such trusts is taxed at the parents’ rate when it exceeds certain thresholds, impacting financial planning.
Beneficiaries can be anyone nominated by the settlor, from minors to adults. The flexibility of being able to name beneficiaries and the irrevocable nature of the trust makes bare trusts a popular choice for those who want to secure their loved ones’ financial future.
Bare Trust Features
Trustees manage the assets until the beneficiaries turn 18 and must keep full records of all transactions so there is transparency and accountability. Keeping accurate records avoids potential liabilities and compliance with the law.
The tax treatment of income from trust assets is another consideration. For example if grandparents put assets in a bare trust for their grandchildren, the income is treated as the child’s for tax purposes. This can be beneficial as it means the child has low tax liability due to their tax free allowances.
Bare trusts provide a simple way to transfer wealth, beneficiaries get immediate entitlement to both capital and income. This is one of the main advantages of using bare trusts for wealth management and estate planning. Additionally, initial gifts into bare trusts can be considered a potentially exempt transfer, allowing the donor to avoid inheritance tax if they survive for seven years, which is particularly beneficial for grandparents aiming to secure financial support for their grandchildren while managing tax implications effectively.
Inheritance Tax Rules for Bare Trusts
Understanding the tax implications of bare trusts is key to good planning. Beneficiaries are taxed on the income received from the trust which is income tax. If the beneficiaries are minors, their parents may be taxed on any income over £100 per annum or £200 for joint gifts.
Inheritance tax is another consideration. If the settlor dies within 7 years of creating the bare trust, the trust’s value is subject to inheritance tax. But if the settlor survives for more than 7 years, there is no inheritance tax, so bare trusts can be a tax efficient way to pass on wealth. Tax authorities play a crucial role in determining the inheritance tax implications of such trusts.
Bare trusts may also be subject to capital gains tax on asset disposals. But they are generally more tax efficient than discretionary trusts with simpler tax rules. So they are a good option for those who want to minimize tax and secure their loved ones’ financial future.
How to set up a Bare Trust
Setting up a bare trust involves several steps, starting with a trust deed or declaration of trust which outlines how the assets will be managed and used. It’s the blueprint for the trust and ensures the settlor’s wishes are followed.
Two to four trustees must be appointed to manage the trust until the beneficiary turns 18. The process also involves naming a beneficiary and how and when the assets will be distributed. Individuals can transfer assets such as cash, property, or investments into a bare trust, effectively transferring control and benefits to the beneficiaries once they meet certain conditions, like reaching a specific age.
New bare trusts must be registered with HMRC’s Trust Registration Service within 90 days. While the registration process is relatively simple, a solicitor can help ensure all legal requirements are met. Proper setup from the start is key to the trust’s smooth running and protection of the beneficiary’s interests.
Transferring Assets into a Bare Trust
Transferring assets into a bare trust is a straightforward process that begins with the settlor, the person creating the trust, transferring the assets into the trust. These assets can include cash, property, investments, or even businesses. It’s crucial to ensure that the trust is properly set up and that the assets are correctly transferred, which may involve seeking professional advice from a solicitor or financial advisor.
Once the assets are transferred into the trust, the trustees take on the responsibility of managing them. They must ensure that the assets are used for the benefit of the beneficiaries, who have an absolute right to both the income and the capital from the trust. The trustees must always act in the best interests of the beneficiaries, adhering to the terms set out in the trust deed.
Benefits of Bare Trusts
Bare trusts have many benefits, used to transfer wealth to minors while the trustees manage the assets until the beneficiaries are old enough to look after them. This makes them perfect for funding education or providing a financial safety net for children.
Another benefit is the flexibility of contributions, family members can contribute together to a child’s future, and there can be more than one beneficiary, such as siblings or a defined group of people. Upon reaching adulthood the beneficiary has the absolute right to withdraw their assets and the income generated, which can be a benefit or a risk depending on their financial literacy.
Bare trusts are tax efficient especially for minor beneficiaries who can use up their tax allowances. This and their simplicity makes them a good option for transferring wealth to the taxman.
Disadvantages of Bare Trusts
Despite the benefits bare trusts have some downsides. One major drawback is the irrevocable nature of beneficiary designations which can’t be changed once set and may be restrictive if circumstances change.
Complications can arise if beneficiaries are not informed of the trust, especially if there is significant income or capital gains tax liability. Informing beneficiaries is key to avoid unexpected tax and ensure they are prepared to manage the trust assets responsibly. Additionally, the parental settlement rules can impact the tax treatment of income generated from such trusts, as income exceeding certain thresholds is taxed at the parents’ rate, affecting financial planning.
Beneficiaries get full control of the trust assets at 18 which can be a benefit but also a risk if they are not financially mature enough to manage the assets. This requires careful thought and planning by the settlor and trustees.
Bare Trusts vs Other Trusts
Bare trusts compared to other trusts shows their differences. Unlike discretionary trusts where the trustees decide how and when to distribute the assets, bare trusts give the beneficiaries immediate entitlement to the trust’s capital and income upon reaching 18.
Bare trusts have no limit on the value of assets they can hold, they are flexible and can adapt to any financial situation, unlike other trusts that have specific limits or more complicated management requirements and can pass assets more easily. Additionally, initial gifts into bare trusts can be considered a potentially exempt transfer, meaning they can be made without incurring inheritance tax if the donor survives for seven years, which is beneficial for inheritance tax planning.
The simplicity and direct control of bare trusts makes them a good option for those looking for a simple way to transfer wealth. But lack of flexibility in beneficiary designations and the risks of young beneficiaries getting full control at 18 are to be considered.
Alternatives to Bare Trusts
While bare trusts can be an effective way to pass assets to beneficiaries, there are alternative options available. One such alternative is a discretionary trust, which grants trustees the flexibility to decide how the assets are distributed among the beneficiaries. This can be particularly useful if the settlor wants to provide trustees with the discretion to manage the assets based on changing circumstances.
Another option is a fixed trust, where the settlor specifies exactly how the assets are to be distributed among the beneficiaries. This can be beneficial if the settlor has a clear vision of how they want the assets to be allocated.
When considering alternatives to bare trusts, it is essential to seek professional advice. The tax implications and rules surrounding each type of trust can be complex, and understanding these nuances is crucial for effective estate planning and wealth transfer.
Managing a Bare Trust
Proper management of a bare trust is key to the beneficiary’s interests. Trustees must manage the investments responsibly, always acting in the best interests of the beneficiary. This means regular reviews of the trust’s performance and informed decisions on asset allocation.
Collaboration with co-trustees is crucial for decision making. Discussing expectations with the settlor and other trustees ensures a common approach and keeps the trust intact and on track.
Trustees must stay up to date with legal and tax requirements to avoid liabilities. Proper management and regular communication with beneficiaries will keep the trust running smoothly and transparently. Tax authorities play a significant role in ensuring compliance with these legal and tax requirements, particularly in relation to inheritance tax obligations.
Acting as a Trustee of a Bare Trust
Acting as a trustee of a bare trust is a significant responsibility that requires careful management and adherence to the trust deed. Trustees are responsible for managing the assets held in the trust, making investment decisions, and ensuring that the assets are used for the benefit of the beneficiaries.
Key responsibilities of a trustee include:
- Managing the assets held in the trust
- Making informed investment decisions
- Distributing income and capital to the beneficiaries as stipulated in the trust deed
- Keeping detailed records of the trust’s activities
- Regularly reporting to the beneficiaries
Given the complexity and time-consuming nature of these responsibilities, it is advisable to seek professional advice before agreeing to act as a trustee. This ensures that the trustee can fulfill their duties effectively and in compliance with legal requirements.
Bare Trusts and Death
When a beneficiary of a bare trust dies, the assets held in the trust are considered part of their estate and may be subject to inheritance tax. The tax implications of a bare trust can be complex, and it is essential to seek professional advice to ensure that the trust is administered correctly.
Generally, the assets held in a bare trust are treated as the property of the beneficiary, meaning the trustee has no discretion in how the assets are distributed. Upon the beneficiary’s death, the assets are distributed according to the beneficiary’s will or the laws of intestacy.
Considering the tax implications of a bare trust when setting it up is crucial, as the rules surrounding inheritance tax and capital gains tax can be intricate. Professional advice can help ensure that the trust is established correctly and that the tax implications are minimized, providing peace of mind for both the settlor and the beneficiaries.
Winding up a Bare Trust
Winding up a bare trust means distributing the assets to the beneficiaries and settling any outstanding obligations. Trustees must prepare final accounts of all transactions of the trust to ensure transparency and accountability during the winding up process. Trustees also transfer assets to the beneficiaries, effectively passing control and benefits to them once all conditions are met.
Beneficiaries must be informed of the termination of the trust and provided with the necessary documents. Outstanding debts and taxes must be settled before distributing the remaining assets. Get releases from beneficiaries to confirm they agree to the distribution of assets and release trustees from further claims.
Record keeping throughout the process is important to document all actions and comply with legal requirements. This thorough approach will ensure a smooth wind up of the trust.
Case Studies and Examples
For example, a grandparent sets up a bare trust for their grandchild’s education, contributes a lump sum and the trustees manage until the child is 18. Upon adulthood the child gets full control of the assets which they can use for education or career.
Another example is parents setting up a bare trust to pass on their estate to their minor children, appointing trustees to manage the assets and provide financial support as the children grow. This setup is a clear and efficient way to transfer wealth and get tax benefits.
A further example involves a family setting up a bare trust with more than one beneficiary. In this case, the trust is established to benefit all the grandchildren, ensuring that each grandchild receives an equal share of the assets when they reach adulthood. This approach can provide financial security for multiple beneficiaries and streamline the management of family wealth.
These examples show how bare trusts can secure a financial future for young beneficiaries, with immediate and long term benefits.
Conclusion
Bare trusts are a simple and efficient way to manage and transfer wealth. Beneficiaries get immediate access to assets upon adulthood, simplicity and tax benefits. But the fixed beneficiary designations and the risk of young beneficiaries managing large sums requires planning.
Understanding the features, tax and management of bare trusts is important if you are considering this option. With proper setup and management, bare trusts can be a powerful tool for your loved ones’ financial future. Additionally, it is crucial to consider the potential impact of capital gains taxes on the assets held in the trust, as these taxes can affect the beneficiaries depending on the jurisdiction.
FAQs
What is a bare trust?
A bare trust gives beneficiaries immediate control of the trust assets when they turn adult. This type of trust is simple and direct to the beneficiaries.
How are bare trusts taxed?
Bare trusts are taxed on the income received by the beneficiaries, they are liable for income tax on that income. Inheritance tax may apply if the settlor dies within 7 years of setting up the trust.
Can beneficiaries of a bare trust be changed?
No, once beneficiaries are named in a bare trust they cannot be changed.
What are the benefits of bare trusts?
Bare trusts are simple to manage, tax efficient and beneficiaries get immediate access to the trust assets when they turn adult.
How do I set up a bare trust?
You need to create a trust deed, appoint at least 2 trustees and register the trust with HMRC’s Trust Registration Service. This will ensure compliance and management of the trust assets.
