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If you're looking for a simple but effective means to pass money on to future generations while also potentially saving thousands of pounds in tax, a bare trust might be the answer.
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"Bare trusts are commonly set up for children as they can't hold equity-based assets in their own name. The asset in the trust is legally the child's but they can't access it until they are 18," explains Chris Mills, tax director at Grant Thornton.
The asset is also regarded as the child's from a tax perspective. This means that if there is any income tax or capital gains tax (CGT) liability it is set against the child's allowances.
There is an exception to this, though, as James Frost, managing director of Witan Investment Services, explains: "If the investment is money from the child's parent and the income exceeds £100 a year, or £200 where both parents have given the money, then it will be treated as the parent's for income tax purposes."
If you're a parent, a way around this is to invest in growth rather than income-producing investments for your child or to stick with investments that are exempt from this rule, such as the Child Trust Fund, friendly society tax-exempt saving schemes or National Savings & Investments children's bonds.
Inheritance tax
As well as income and CGT advantages, bare trusts also have inheritance tax planning (IHT) benefits. Bare trusts are treated as a potentially exempt transfer (Pet) so providing you live for a further seven years from the point you put the asset into trust it will be outside your estate for IHT purposes.
Some assets can be exempt instantly. "If you put up to £3,000 a year into a bare trust, this would qualify for your annual IHT exempt gift exemption," says Mr Frost. "Additionally, if it's a regular payment out of taxed income then this would be exempt, too."
Although you need to be mindful of the seven-year rule for Pets, there are no limits on the amount you can put into a bare trust. This gives them an advantage over other forms of trust, such as the discretionary trust, for example, which is often used for estate planning. Unlike the bare trust, these are subject to tax charges if you put in more than the IHT nil-rate band (£312,000 for 2008-09 tax year).
But, while they can deliver hefty tax advantages, there are some pitfalls to avoid if you're setting up a bare trust. "Be careful about what you put into a bare trust as you might create a tax charge of your own," warns Mr Mills. This won't be the case if you're starting a new investment, but if you're transferring an existing investment you hold in your name you might find yourself with a capital gains tax liability.
Additionally, while it's very easy to set up a bare trust for a child, with many of the investment houses providing all the necessary paperwork for free, it's not so easy to reverse the process. "You can change the underlying investments but, once the paperwork has been completed and witnessed, it's irrevocable," says Mr Frost.
Further, as the child will be automatically entitled to the money when they are 18, you might want to consider carefully how much money you put in a bare trust. Alternatively, a different form of trust may be more appropriate. Although they have stricter tax regimes if you exceed the IHT nil-rate band, they can offer greater flexibility and control over where the money goes and when.
For these reasons, Mr Mills recommends getting advice if you're considering a bare trust. "Unless it's a very straightforward situation where you're putting some money away for a child's future, you should take legal and tax advice to be certain it's appropriate," he explains.
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-IC-1.9.0c-prod - 15/05/2009 11:00:33 - stuart.turner
