Bare Trust Definition
A bare trust refers to a basic trust where a beneficiary has all the rights to the trust’s assets, capital, and income earned from the assets. Bare trusts are mostly utilized by parents and grandparents when they want to hand over the assets to their children and grandchildren. The assets are held under the trustee’s name. The trustee has a duty of managing trust assets to ensure profit maximization for the beneficiaries. However, the trustee does not have control over how and when the distribution of income or capital should be.
A Little More on What is a Bare Trust
Generally, a bare trust is a tool through which parents and grandparents transfer assets to their children and grandchildren. The arrangement is that the trustee takes care of the trust until the beneficiary becomes of age. Bare trust has rules that permit beneficiaries to make a decision as to when they would like to recover the trust assets provided that they are above 18 years. When a beneficiary reaches this age, he is free to use the trust’s income as well as the capital whenever and however he wants.
A bare trust creator is supposed to stipulate the age a beneficiary of the trust is supposed to attain before it is handed over to him or her. But if the trust creator dies before stipulating it, and the beneficiary happens to be below 18 years, then his death automatically creates a bare trust for the beneficiary.
Also, note that before the beneficiary turns 18 years, both the income and capital generated from the trust can only be spent for the beneficiary’s benefit and not anyone else in the will.
How Bare Trust Works (Example)
Let’s assume that John leaves his daughter money in his will, though she is not yet of age. That money is put in a trust where a trustee holds it until she becomes of age (she is 18 years old). The daughter can only take over the possession of the money when she reaches18 years of age and can spend it at her own pleasure.
Why Bare Trust is Different from Other Trusts
A bare trust is different from the rest of the trusts. For instance, income earned from trust assets is usually in the form of dividends, rent, and interest, taxed to the asset’s legal owner who, in this case, is the beneficiary. The stipulation gives the beneficiary tax relief, especially if he or she is a low earner.
The reason is that tax policies related to bare trust are mostly in favor of beneficiaries overtrusts. In this case, they need to report income earned by the capital gains and trust assets that surpasses the annual exemption in their individual tax returns.
Generally, the levying of tax is usually on the settlor or creator of the trust, especially if the beneficiary of the trust is underage. For example, let’s assume that a grandparent opens a bare trust for his or her infant grandchild. In this case, the grandparent will have to pay any tax resulting from the trust assets’ earnings until the grandchild turns 18 years.
Bare Trust Inheritance’s Implications
- Though the tax obligation is usually on the creator of the trust, beneficiaries may at some point, find themselves paying inheritance tax. A beneficiary pays the tax if the settler of the trustee dies within seven years of trust establishment. The reason for this is that tax authorities do treat bare trusts as possible exempt transfers. However, in case the creator happens to live past those seven years, there will be no tax owed.
- When an individual sets up a bare trust, he or she will have no tax obligation. The reason is that after the transfer of the assets to the trust, the individual will have given up the legal ownership of those assets.
- Bare trust has no room for reverse. What this means is that once the creator of the trust assets puts to effect the transfer of the assets to the beneficiary, he or she cannot reverse it.
- According to bare trust policies, a beneficiary of a bare trust who dies before attaining the age of 18 years, his or her trust assets will have to pass through the intestacy rules. This is because an individual below the age of 18 years is a child and is not in a position to make a will. For this reason, inheritance tax charges will apply only if the value of the trust assets surpasses the tax-free allowance of the child.
Tax-Related to Bare Trust
Generally, for the purpose of taxing, the beneficiary is usually considered as the trust asset owner. So, the arrangement of a bare trust usually taxes efficiently from capital and income returns. The taxation is done at the child’s marginal rates. The following types of taxes apply to bare trust:
- Income tax: Income tax: This is a tax which a beneficiary of a bare trust pays on income or capital gains generated from the trust assets. Note that the beneficiaries of a bare trust are considered to be holders of the trust, a situation that makes them liable to income tax on earnings from assets.
- Capital gain tax: This refers to tax payable on profits gained from trust assets that are above a certain level, as per the trust’s policies. The tax applies to any gains above the annual exempt amount set yearly.
- State-related transfer duties: There are charges involved during the transfer of assets from a trust creator to the beneficiary.