Absolute/Bare Trusts

A bare trust is one where the person who benefits from it (referred to as the beneficiary) has an immediate and absolute right to the assets that are transferred to the trust and any income generated by them. The property is held in the name of the trustee (or trustees), but the trustee has no discretion over the assets held in trust. The trustee of a bare trust is a mere nominee, in whose name the property is held. Except in the case of bare trusts for minors, the trustee has no active duties to perform.

A person setting up a bare trust can be certain that the assets they set aside for the beneficiary will go to that person because once the trust has been created, the beneficiary cannot be changed. The settlor cannot benefit from the Trust to be effective for IHT. Gifts into Absolute Trusts continue to be potentially exempt transfers (PETs) for Inheritance tax purposes. If the donor survives 7 years there is no IHT. If the beneficiary would be liable to IHT it becomes a failed PET.

Absolute Trusts/Bare trusts are treated for tax purposes as if the beneficiary holds the trust property in his or her own name. Income tax and capital gains tax are charged on the beneficiary, as if the trust did not exist.

The beneficiary must declare any income and capital gains on his or her personal tax return. Although trustees can pay income tax on behalf of a beneficiary, it is the beneficiary who is chargeable to tax.  Unlike some other trusts assets that are not protected from bankruptcy.

Discretionary Trust

Unlike an absolute or bare trust the nominated ‘trustees’ are the legal owners of any assets – known as ‘property’ – held in a discretionary trust. The trustees are responsible for running the trust for the benefit of the beneficiaries. So the beneficiary cannot demand assets.

The settlor is the person who creates the trust by “settling” a sum of money or item of property on trust for the beneficiaries.

The trustee is the legal owner of the trust property although not the beneficial owner. The trustee carries out all transactions of the trust in its own name and must sign all documents for and on behalf of the trust. The trustee’s overriding duty is to obey the terms of the trust deed and to act in the best interests of the beneficiaries.

A trust deed will name the beneficiaries. Although it will be at the discretion of the trustees to decide which of the beneficiaries to pass assets on to, when, and how much each will receive, you can indicate to the trustees how you would like them to exercise their discretion but your wishes are not legally binding on them. Another difference between a Bare and discretionary trust is that the beneficiaries may be changed.

While discretionary trust assets are legally owned by the trustee, the trustee does not beneficially own the assets. The trustee must, however, manage and safeguard the assets for the general body of potential beneficiaries, but no beneficiary can demand an asset or income from the trustee.

The trustees of a discretionary trust can choose how to deal with any income generated within the trust, as they can either accumulate this or distribute it to the beneficiaries, or a combination of the two.

The creation of a discretionary trust is a chargeable lifetime transfer chargeable at 20% on the extent that the transfer takes the settlors cumulative total over the nil rate band. So there may be further tax to pay if the settlor dies within 7 years of creating the trust. However taper relief is available if the transfer does use up all of the nil rate band. Gifts must be reported to HMRC

If the trustees opt to accumulate the income within the trust the trust will be subject to income tax rates of 45 per cent on rental income and interest from savings, and 37.5 per cent on dividends. 

Any income distributed to the beneficiary will be deemed to be trust income and will be received with a 45 per cent tax credit, and does need to be included within your self-assessment submission to HMRC. 

You can possibly reclaim all or part of this tax credit depending upon your tax status. 

An IHT 10 year periodic charge is made on the 10th anniversary of the creation of the trust. This is 6% of the value excess over the nil rate band. In addition an exit charge is payable every time capital distribution

Because no beneficiary has the right to either income or capital from a discretionary trust, there is nothing to include in the value of their estate on death.

Interest in Possession Trust

An interest in possession trust is one where the beneficiary of a trust has an immediate and automatic right to the income from the trust as it arises. The trustee (the person running the trust) must pass all of the income received, less any trustees’ expenses, to the beneficiary. The beneficiary entitled to the income of the trust for life is known as a life tenant or as having a life interest, and a beneficiary who is entitled to the trust capital is known as the capital beneficiary. Different trust funds have different benefits depending on your individual circumstances and the outcomes you wish to achieve. 

It is important to obtain independent and impartial advice – but also to speak to family members you trust regarding your decision. Interest in possession trusts are best suited to:

Couples who want to ensure that their surviving partner has a safe, stable source on income when they are gone.Individuals who’d like to retain some of their assets to pass on to family members and children at a later dateIndividuals who wish to protect their property from being considered in financial assessments to determine how much they can pay towards future care costs.

Where a person would like their surviving spouse to have the right to remain in the matrimonial home until they die but would ultimately like their children to inherit their estate. This can help guard against possibility of the estate passing to a new spouse should the surviving spouse remaryWhere a person has children but  is married to someone other than the other parent of the children and would like their surviving spouse or cohabitee to have the right to remain in the home until they die but would ultimately like their children to inherit their estate.

This “interest in possession” can be written into the trust deed for a fixed number of years, or for the rest of the beneficiary’s life or indefinitely.

An In terest in Possession trust is generally considered a lifetime transfer and the IHT treatment is the same as a discretionary trust

Again as with discretionary trusts they are subject to periodic and exit charges, unless it’s a disabled trust or Interest in Possession trust, created on death by Will or intestacy Before 22 March 2006. All IIP trusts are treated for inheritance tax (IHT) purposes as though are were owned by the beneficiary with the IIP.

An IIP trust created on or after 22 March 2006 is only treated in this way if it is one of the above.

In comparison with Discretionary Trusts, Interest in Possession Trusts are less suitable for minors, as income must be distributed to beneficiaries. An Interest in Possession Trust can be a useful solution, but whether it is applicable has to be determined on a case-by-case basis.