A bare trust is a unique type of trust offering beneficiaries total ownership rights over the capital and assets within it, including any income that these assets generate. Here’s a deep dive into how bare trusts function, their benefits, and the tax implications involved.
Trust assets are managed under a trustee’s name, whose sole responsibility is to safeguard these assets and ensure they benefit the beneficiary. Notably, the trustee cannot decide how or when the assets and income of the trust are distributed.
Bare trusts are commonly set up in Canada and the United Kingdom, but not in the United States.
Key Insights
- Bare trusts, sometimes referred to as “naked trusts,” give beneficiaries who are 18 years or older the absolute right to the trust’s capital, assets, and income.
- These trusts offer notable tax benefits to those setting them up, especially when beneficiaries may be taxed at lower rates owing to low earnings.
- Once beneficiaries are named in a bare trust, the designation cannot be altered.
What Makes Bare Trusts Stand Out?
Bare trusts, also known as simple trusts or naked trusts, are often utilized by parents and grandparents to transfer assets to their children or grandchildren securely. In the UK, once beneficiaries reach 18, they have unrestricted access to the assets and income, using them as they see fit.
A bare trust is often formalized through a deed of settlement or a declaration of trust. The fundamental characteristic of such a trust is that, while the assets are held by the trustee, the trustee has no decision-making powers beyond those directed by the beneficiary.
Tax Benefits of Bare Trusts
One particular benefit of bare trusts lies in their tax structure. Earnings from trust assets such as interest, dividends, and rent are taxed to the beneficiary as the legal owner, possibly providing significant tax relief compared to other trusts. Beneficiaries must report these earnings and any capital gains over the annual exemption in their tax returns.
If the beneficiary is under 18, the taxes on the income generated by the trust assets fall to the trust’s creator (settlor). For example, if a grandparent sets up a bare trust for a grandchild, the grandparent will pay taxes until the child turns 18.
Inheritance Tax Implications
Regarding inheritance tax, the beneficiary might owe inheritance tax if the settlor dies within seven years of establishing the trust due to their status as potentially exempt transfers. However, if the settlor survives those seven years, no inheritance tax is applied. The advantage for the trust creator is they relinquish legal title to the assets once they are placed into the trust, incurring no tax.
In essence, once you designate a beneficiary or beneficiaries to a bare trust, this decision is irreversible.
By understanding how bare trusts operate, you can unlock considerable tax advantages and secure a clear line of asset succession for your beneficiaries. As financial advisors often say, it’s not just what you save, but also how you distribute and manage those savings for the future.
Related Terms: Capital Gains, Dividend, Settlors, Title, Income Tax.
