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What Is a Bare Trust?
A bare trust is a trust structure in which the beneficiary has full rights to the trust’s assets and income, with the trustee holding legal title but no discretion over how or when funds are distributed. Common in Canada and the U.K., bare trusts are often used to transfer assets tax-efficiently, especially to lower-income beneficiaries who may pay less tax on investment returns.
Unlike more complex trusts that give trustees decision-making power, bare trusts offer little flexibility but clear control for beneficiaries. They are not permitted in the United States.
Key Takeaways
- Bare trusts give beneficiaries immediate and absolute ownership of trust assets and income, commonly used in the U.K. and Canada.
- Trustees manage bare trust assets following the beneficiary’s directions but cannot dictate distribution timing or method.
- Income generated from bare trust assets is taxed at the beneficiary’s rate, potentially offering tax benefits for low-income earners.
- Bare trusts cannot change beneficiaries once established and may involve inheritance tax if the settlor dies within seven years.
- Bare trusts offer a cost-effective and tax-efficient method for asset transfer, even allowing for securities to be held for minors.
Exploring the Basics and Benefits of Bare Trusts
Also known as simple trusts or naked trusts, bare trusts are widely used by parents and grandparents to transfer assets to their children or grandchildren. Bare trust rules allow beneficiaries to decide when they want to recover the trust’s assets as long as they are at least 18 years of age in the United Kingdom. Beneficiaries can use the capital and income they inherit from a bare trust any way they please.
A bare trust is established using a deed of settlement or a declaration of trust. In the simplest form of a bare trust, the assets bequeathed by the individual who set up the bare trust are owned by the trustee and beneficiary. But the trustee, in a bare trust, has no responsibilities or powers. They act per the beneficiary’s instructions.
Bare trusts differ from other trusts because the beneficiary is taxed on income from the trust’s assets, like interest and rent, since they are the legal owner. This can result in tax savings for low-income beneficiaries, as tax laws usually favor individuals over trusts.
Beneficiaries would have to report income generated by the trust assets as well as capital gains that exceed the annual exemption in their Self Assessment tax returns.
This tax will be levied on the trust’s creator or settlor, however, if the beneficiary is under the age of 18. For example, a grandparent opening a bare trust for an infant grandchild would have to pay taxes on the income generated by trust assets until the infant beneficiary turns 18.
Important
Once a beneficiary or beneficiaries for a bare trust are set, the decision can’t be reversed.
How Bare Trusts Impact Inheritance Taxes
Beneficiaries might pay inheritance tax if the trust creator dies within seven years of setting up the trust, as tax authorities view bare trusts as potentially exempt transfers. No inheritance tax is due if the settlor lives past seven years. The person setting up the trust avoids taxes because they transfer legal ownership of the assets to the trust.
What Happens to a Bare Trust When You Die?
In the U.K., the beneficiary of a bare trust is entitled to both the assets and the income in the trust. When the beneficiary of a bare trust dies, the income and assets are considered part of their estate, and may be passed on to their own heirs and beneficiaries.
What Are the Advantages of a Bare Trust?
In countries that allow them, bare trusts have tax advantages for the grantor, and they are cheaper and easier to set up than other kinds of trusts. In addition, if the beneficiary is younger than 18, a bare trust also allows assets they could not otherwise hold, such as securities.
What Are the Disadvantages of a Bare Trust?
The main issue with bare trusts is that the beneficiaries cannot be amended after the trust is set up. In addition, depending on the jurisdiction, the assets in the trust may be subject to inheritance or capital gains taxes.
The Bottom Line
Bare trusts give beneficiaries full and immediate ownership of assets, unlike other trust types, where trustees have discretion. Used mainly in Canada and the U.K. for tax-efficient wealth transfers, especially to lower-income beneficiaries, they are fixed once created, offering certainty but little flexibility.
Trustees act only in an administrative capacity, and inheritance tax rules still apply, such as potential liability if the settlor dies within seven years. The U.S. does not allow bare trusts.
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