The benefits of using a Trust

Trusts can be a vital tool in wealth management, offering individuals a structured way to secure their financial legacy for future generations. Whether safeguarding assets for children, planning for inheritance tax efficiency (IHT), or protecting vulnerable family members, trusts provide tailored solutions to meet specific needs. Among the various types available, Bare Trusts and Discretionary Trusts stand out as popular choices, each with its unique advantages and considerations. Understanding these trust types and their implications can help individuals make informed decisions about their estate planning.

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What is a trust?

A trust is a legal arrangement where assets, such as cash, property, or investments, are held and managed by Trustees on behalf of Beneficiaries. Trusts are often used to control how and when assets are distributed, provide financial security, and mitigate tax liabilities. Depending on the trust type, the flexibility and control over these assets can vary significantly, making it essential to choose the right arrangement for your specific goals.

Two commonly used trusts, bare trusts and discretionary trusts, cater to different needs and offer distinct benefits. While bare trusts are simple and straightforward, providing Beneficiaries with clear rights to the trust's assets, discretionary trusts offer greater flexibility and control, allowing Trustees to adapt to Beneficiaries’ changing circumstances.

Bare trusts: simplicity and certainty

Bare trusts, also known as simple trusts, are the most straightforward type of trust arrangement. Under a bare trust, the trustees hold assets in their name, but the beneficiary has an absolute right to both the capital and any income generated by the trust. Importantly, the assets in a bare trust fully belong to the beneficiary, who can access them when they reach the age of 18 (or 16 in Scotland).

The simplicity of bare Trusts makes them particularly appealing for individuals looking to transfer assets to children or grandchildren for specific purposes, such as funding education. Because the beneficiary is the outright owner of the assets, any income or capital gains are taxed as if they belong to the beneficiary. This can result in tax efficiencies, especially if the beneficiary falls within a lower tax bracket than the settlor.

However, the simplicity of bare trusts also means that they are best suited for straightforward scenarios where the Beneficiaries' needs and entitlements are clear. Once the beneficiary reaches the age of majority, they gain full control of the assets, which may not align with the intentions of settlors who wish to impose long-term conditions on asset use.

Discretionary Trusts: flexibility and control

In contrast to bare Trusts, Discretionary Trusts grant Trustees significant flexibility in managing and distributing trust assets. Instead of naming specific Beneficiaries with fixed entitlements, a Discretionary Trust identifies a class of Beneficiaries—such as children, grandchildren, or dependents—and gives Trustees discretion over how and when to allocate the assets. This flexibility makes Discretionary Trusts particularly valuable in situations where Beneficiaries’ needs may evolve over time.

For instance, Discretionary Trusts are often used to support vulnerable family members who are unable to manage their finances independently. Trustees can allocate funds to ensure these Beneficiaries’ needs are met without jeopardising their financial security. Similarly, Discretionary Trusts are ideal for long-term planning when Beneficiaries have yet to be born or when their financial circumstances are uncertain.

While Discretionary Trusts offer considerable advantages, they come with inherent complexities. The settlor relinquishes control of the assets when they are transferred into the trust, and Trustees must manage the assets in accordance with the terms of the trust deed. Trustees are also responsible for ongoing administrative tasks, including holding regular meetings, maintaining detailed records, and filing tax returns. These obligations can lead to additional costs, as trustees may need to seek professional advice to ensure the trust is managed correctly.

Tax considerations for trusts

Both bare and Discretionary trusts come with specific tax implications that should be carefully considered when deciding which arrangement to use.

For bare trusts, the tax liability generally falls on the beneficiary, which can be advantageous if the beneficiary is in a lower tax bracket. This arrangement is particularly valuable for younger Beneficiaries who have little to no income of their own.

• Discretionary trusts, however, are subject to more complex tax rules. Any gifts made into a Discretionary trust are considered Chargeable Lifetime Transfers (CLTs) for inheritance tax (IHT) purposes. If the value of the gift exceeds the nil rate band (currently £325,000 for the 2024/25 tax year), an immediate IHT charge may apply. Furthermore, these trusts are subject to periodic tax charges, including a maximum 6% charge on every ten-year anniversary of the trust and potential exit charges when assets are distributed to Beneficiaries. Trustees are also responsible for paying income tax on any income generated by the trust, which is taxed at the additional rate of 45% (39.35% for dividends). 
• Capital gains tax (CGT) is another consideration for Discretionary trusts. While trusts benefit from an annual CGT exemption, this is significantly lower than the exemption available to individuals. For the 2024/25 tax year, the trust exemption is capped at £1,500, with gains above this threshold taxed at a rate of 24%.

Choosing the right trust for your needs

Selecting the right type of trust depends on your financial goals, the needs of your Beneficiaries, and your tolerance for administrative complexity. bare trusts are ideal for straightforward scenarios where Beneficiaries have clear, fixed entitlements and are expected to responsibly manage the assets upon reaching adulthood. By contrast, Discretionary trusts are better suited to situations that require flexibility, such as providing for future generations, supporting vulnerable family members, or adapting to changing circumstances.

Given the complexities involved in setting up and managing trusts—particularly Discretionary Trusts—it is crucial to seek professional advice. A qualified financial adviser can help you navigate the tax implications, evaluate your options, and structure a trust arrangement that aligns with your objectives.

How we can help

Trusts remain one of the most effective tools for managing wealth, offering tailored solutions to preserve and protect assets for future generations. Whether you opt for a bare trust or a Discretionary trust, each arrangement provides unique benefits that cater to different circumstances. By understanding the advantages, drawbacks, and tax implications of each type, you can make an informed decision that ensures your financial legacy is secure.

If you’d like to learn more about how which trust arrangement might be suitable for your needs, why not get in touch and speak to one of our expert advisers. With clear guidance, you can create a trust that not only safeguards your assets but also provides peace of mind for you and your loved ones. 

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This article is intended for general information only, it does not constitute individual advice and should not be used to inform financial decisions. 

The Financial Conduct Authority (FCA) does not regulate estate planning, tax, wills or trust advice.