IHT and Bare Trusts: How Inheritance Tax Applies to Bare Trusts in the UK
A bare trust is IHT-transparent — the beneficiary is treated as absolutely entitled under s49 IHTA 1984, so the assets are in the beneficiary's estate, not the trust. Transfers into a bare trust are PETs, not CLTs. No 10-year charge. No exit charge. Used widely for children's gifts and straightforward estate planning.
Bare Trust vs Discretionary Trust: IHT Comparison
| IHT Feature | Bare Trust | Discretionary Trust |
|---|---|---|
| Who 'owns' the assets for IHT? | The beneficiary — absolutely entitled under s49(1) IHTA 1984 | The trust itself (relevant property) — no individual beneficiary has absolute entitlement |
| Transfer into the trust | PET — potentially exempt, no immediate IHT, subject to 7-year survival rule | CLT — immediately chargeable at 20% above the NRB (lifetime rate); 40% if settlor dies within 7 years |
| 10-year periodic charge | None — no relevant property regime applies | Up to 6% of the trust value every 10 years above available NRB |
| Exit charge (distribution from trust) | None — beneficiary is already treated as owning the assets | Pro-rata charge between 10-year anniversaries; rate based on time elapsed |
| Death of beneficiary | Assets form part of beneficiary's estate; IHT at 40% above beneficiary's NRB | Trust assets not in deceased beneficiary's estate (unless IPDI or s49 interest) |
| Death of settlor within 7 years | PET becomes chargeable — falls back into settlor's estate; taper relief applies years 3–7 | CLT: additional tax if death rate (40%) exceeds lifetime rate (20%) already paid |
| Income tax | Beneficiary taxed directly on trust income at their own marginal rate | Trust pays tax at 45% (income) / 39.35% (dividends); beneficiary receives a credit |
Frequently Asked Questions
What is a bare trust for IHT purposes?
A bare trust (also called a simple trust or nominee trust) is an arrangement where the trustee holds assets for the benefit of one or more beneficiaries who have an immediate, absolute, and indefeasible right to the trust assets and income. The defining feature is absolute entitlement: the beneficiary can demand the assets be transferred to them at any time (once they are 18 in England and Wales). For Inheritance Tax purposes, s49(1) IHTA 1984 treats a person with an 'interest in possession' that is an 'immediate post-death interest' or a pre-22 March 2006 interest in possession as owning the underlying assets. Bare trusts take this further — the beneficiary's absolute entitlement means the bare trust is entirely transparent for IHT: the trust assets are simply treated as the beneficiary's assets, not the settlor's and not held in a separate relevant property trust.
Is a transfer into a bare trust a PET or a CLT for IHT?
A transfer into a bare trust is a potentially exempt transfer (PET), not a chargeable lifetime transfer (CLT). This is a critical and favourable distinction. Because the beneficiary is absolutely entitled under s49 IHTA 1984, the transfer is treated as a direct gift from the settlor to the beneficiary — just one step removed by the trust wrapper. As with all PETs: (1) no IHT is due at the time of the transfer; (2) if the settlor survives 7 years, the gift is fully exempt from IHT; (3) if the settlor dies within 7 years, the PET becomes chargeable and falls back into the settlor's estate (with taper relief reducing the IHT for deaths in years 3–7). Contrast this with a discretionary trust, where the transfer in is a CLT — immediately chargeable at 20% above the nil-rate band, with further tax on death if the settlor dies within 7 years.
Are bare trusts subject to the 10-year periodic charge?
No — the 10-year periodic charge (also called the anniversary charge) is part of the 'relevant property regime' under Chapter III IHTA 1984. This regime applies to discretionary trusts and most post-22 March 2006 trusts. Bare trusts are not relevant property trusts — the beneficiary is absolutely entitled to the assets. Accordingly, bare trusts are not subject to: (1) the 10-year anniversary charge (up to 6% of the trust value above the nil-rate band); (2) exit charges when assets are distributed. The absence of these charges makes bare trusts substantially more tax-efficient than discretionary trusts for straightforward gifting to known beneficiaries — provided the settlor is comfortable that the beneficiary will have an unconditional right to the assets at 18 (or immediately, if the beneficiary is already an adult).
Can bare trusts be used to hold assets for children under 18?
Yes — this is one of the most common uses of a bare trust. Minors (under 18) cannot hold legal title to assets directly. A bare trust allows a parent or grandparent to make an outright gift to a child (treated as a PET from the settlor) with the trustees holding the assets until the child reaches 18, when the child becomes legally entitled to demand the assets. The IHT position: the gift into the bare trust is a PET. If the donor survives 7 years, the assets are permanently outside the donor's estate. If the donor dies within 7 years, the PET becomes chargeable, falls back into the estate, and potentially attracts IHT. The assets are in the child's estate for IHT on the child's death (unlikely at young ages). Grandparents using this structure to pass wealth to grandchildren can combine the bare trust with the £3,000 annual exemption and the small gifts exemption (£250 per donee) to shelter modest annual gifts outside the 7-year PET clock entirely.
What happens to the bare trust assets if the beneficiary dies before taking ownership?
If the beneficiary dies (whether before or after reaching 18), the bare trust assets form part of the beneficiary's estate for IHT purposes — because the beneficiary was absolutely entitled to them under s49 IHTA 1984. IHT is assessed on the beneficiary's estate, including the bare trust assets, at 40% above the beneficiary's own nil-rate band. The bare trust assets do not revert to the settlor's estate on the beneficiary's death (unless the trust deed provides for this, which would undermine the bare trust structure). This means that for IHT planning over multiple generations, a bare trust in favour of a single beneficiary carries the risk of being taxed in that beneficiary's estate — unlike a discretionary trust, where no individual beneficiary 'owns' the assets for IHT. Where the goal is keeping assets outside all potential beneficiaries' estates (e.g. for long-term asset protection), a discretionary trust is preferable despite the relevant property charges.
How does a bare trust differ from a discretionary trust for IHT planning?
The key differences are: (1) Transfer in: bare trust = PET; discretionary trust = CLT (immediately chargeable at 20% above NRB). (2) Ongoing charges: bare trust = none; discretionary trust = 10-year anniversary charge up to 6% + exit charges. (3) Control: bare trust = settlor cannot revoke or redirect once established; discretionary = trustees have full discretion over distribution and can respond to beneficiaries' changing needs. (4) Beneficiary estate: bare trust assets ARE in the named beneficiary's estate; discretionary trust assets are NOT in any beneficiary's estate (unless an interest in possession exists). For straightforward gifts to a known adult beneficiary or a child who will receive at 18, a bare trust is usually the simpler and more tax-efficient option. For more complex arrangements — multiple potential beneficiaries, the need to vary distribution between family members, or protecting assets from a beneficiary's creditors or divorce — a discretionary trust provides flexibility that a bare trust cannot.
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