Trusts can help to ensure that the right people inherit your wealth in accordance with your wishes. There are also certain types of trust that can be used during the course of your own lifetime so as to help your loved ones with things like educational fees and care costs.
Whilst you should always seek professional advice when setting up a trust, understanding the nature of how a trust works can be the first step towards managing your personal assets for the benefit of your loved ones.
Below we look at the bare trust, what this does and when it can be used.
What is a bare trust?
A bare trust, commonly referred to as a simple or absolute trust, is the most basic kind of trust available. It arises where assets are transferred into trust by the settlor for the trustees to hold for a specific beneficiary absolutely until they attain the age of majority.
What does a bare trust do?
The bare trust creates a fixed and absolute interest in the trust fund. As such, having turned 18, the named beneficiary has an automatic entitlement to demand payment of both the trust income and capital.
Having called for the legal interest from the trustee(s), the beneficiary will be given ownership over the trust fund, thereby effectively bringing the trust to an end. The beneficiary is then free to use the capital and income they inherit from the bare trust in any way they please.
When does a bare trust work well?
Bare trusts can be useful in a number of scenarios, in particular when used by parents and grandparents to pass on assets after they die to their children and grandchildren, especially where the beneficiaries are still minors.
However, the bare trust can also be an especially useful option for grandparents wanting to help fund their grandchildren’s education. Here a grandparent can open an investment account designated for their grandchild with a gift. The account will then act as a default bare trust to pay for fees directly.
What other types of trust are available?
There are various other types of trust available, each with different benefits and drawbacks. It is important to understand the different types of trust and how these work in order to make an informed decision as to which trust will work best for you. Below we look at some of the main types of trust.
The discretionary trust
The discretionary trust is much more flexible than the bare trust. It is so called because no beneficiary has a fixed or absolute entitlement to any share in it.
The trustees will decide the extent to which any benefits are received and by whom. Where a wide discretion is conferred on the trustees, the settlor may additionally provide a ‘Letter of Wishes’ with specific guidance on how to manage and administer the trust fund.
The interest in possession trust
An interest in possession trust is a trust that gives the initial beneficiary an entitlement to receive any income from, or to use property comprised in, the trust for a defined period.
Where this is for the life of the beneficiary, the interest in possession ends on their death, at which stage the trust assets will pass absolutely to the subsequent beneficiary or class of beneficiaries.
The accumulation and maintenance trust
An accumulation and maintenance trust is a mixed trust, specifically intended to make provision for children and young adults up to the age of 25.
This type of trust combines the discretionary trust and interest in possession trust, such that the trustees are given the discretion how to use the income for the benefit of the child up to a specified age and, thereafter, the beneficiary acquires the automatic and absolute right to the trust fund.
What are the advantages of the bare trust?
There are several advantages to using a bare trust over and above other types of trust, not least that the bare trust is much cheaper and easier to establish than the other types. In some cases a trust deed is not even required.
However, one of the biggest advantages of the bare trust is its’ tax treatment. The money contained within the trust is, for tax purposes, treated as if it belongs to the child. As such, in the case of a trust set up to pay for a grandchild’s school or university fees, that child can use their own annual personal income tax allowance, personal savings allowance and capital gains tax exemption.
If the grandchild has no other income, and income and gains generated within the trust fall within their personal allowance, they should not need to complete a tax return form.
Furthermore, because the creation of the bare trust is a ‘potentially exempt transfer’ for inheritance tax purposes, so long as the settlor survives for 7 years following the gifting of the trust assets, the gift should fall outside the settlor’s estate. Under the rules relating to taper relief, inheritance tax will be payable on a sliding scale where the settlor dies between 3 and 7 years after the gift.
Please note, however, that this type of arrangement for educational fees, and the like, only works for grandparents, and is not suitable for parents. This is due to anti-avoidance rules meaning there are no tax advantages to parents gifting money via a bare trust.
What are the disadvantages of the bare trust?
One of the main disadvantages to the bare trust is that the structure of the trust is very rigid. Typically, neither the beneficiaries, nor the share in which they benefit, can be altered once the trust has been established.
There is no flexibility in terms of future beneficiaries as the trust has been set up absolutely for the benefit of the named grandchild, nor can the trust be reversed. Any gift made under a bare trust is irrevocable, and cannot be repaid.
Furthermore, the age at which the beneficiary can access the trust fund is set. The beneficiary is automatically and absolutely entitled to any money or investment remaining in the trust at the age of 18, whereby the age of receipt cannot be increased.
For this reason, the bare trust is rarely suitable for large sums of money, as this would give the young adult immediate access to such funds, with the freedom to spend it on anything at all. The trustee has no discretion whatsoever whether to comply with a request from the adult beneficiary to assign to them control of the trust assets once they have reached the age of majority.
That said, with a bare trust set up to pay for educational fees, where the costs can be estimated from the outset, the trust can be funded sufficiently to cover these costs, leaving only a minimal balance by the time the grandchild reaches 18.
Why take legal advice?
The rules relating to trusts, even bare trusts, can be complex and subject to change. Accordingly, professional advice should be sought for any trust matters, including the question of “what is a bare trust?”.
Your legal adviser can talk you through the various options, including the advantages and disadvantages of each type of trust, helping you to tailor a solution to fit your particular needs.
For more information on the benefits and drawbacks of discretionary trusts, interest in possession trusts, and accumulation and maintenance trusts please seek expert legal advice.
Bare trust FAQs
What is the difference between a trust and a bare trust?
A bare trust, also called an absolute or fixed interest trust, is the most simple form of trust, and is commonly used to transfer ownership of assets to a small group of people.
What is a bare trust structure?
A bare trust has a basic structure, with the beneficiary having the right to all trust capital, assets and any income generated from those assets.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law and should not be treated as such.
Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission.
Before acting on any of the information contained herein, expert legal advice should be sought.