Bare Trust vs. Discretionary Trust 

This is a question that we discuss with our clients, when putting in place a Discounted Gift Trust (DGT) arrangement. In this article we describe the difference between the two options and show how this can be applied to a real-life scenario.

Firstly, it is important to point out that the type of Trust you use, can have a significant impact on the potential liability to tax. Each Trust can present a different planning opportunity, and the most suitable Trust for you will depend on your circumstances and objectives.

What is the difference between a Bare (Absolute) Trust and a Discretionary Trust?

Typically, a lot of DGTs are put into a discretionary Trust instead of a Bare Trust, due to the flexibility it offers. However, in some cases, it could be more suitable to use a Bare Trust.

Bare Trust

In a Bare Trust, also known as an Absolute Trust the settlor selects specific beneficiaries for the Trust’s assets, and this cannot be changed. The beneficiary has an absolute right to both the income and the capital of the Trust once the settlor has passed away and the settlor’s lifetime ‘income’ rights have ended. The trustee’s role is to manage the assets on behalf of the beneficiary.

Gifting funds into a Bare Trust is classed as a Potentially Exempt Transfer (PET). This means the gift has the potential to be exempt from Inheritance Tax (IHT) if the settlor survives for seven years following the gift. There is no limit to the value of PETs.

Discretionary Trust

In a Discretionary Trust, the settlor selects potential beneficiaries in the trust deed and gives trustees the power to decide who gets the trust income or capital, and when, once the settlor has passed away and the settlor’s lifetime ‘income’ rights have ended. This type of Trust is more flexible.

The settlor might write a letter of wishes to guide the trustees on how to use their powers, but trustees do not have to follow it. Beneficiaries do not have a guaranteed right to the funds.

Gifting funds into a Discretionary Trust is classed as a Chargeable Lifetime Transfer (CLT). Such gifts are immediately chargeable to IHT, unless the gift falls within the Settlors Nil Rate Band (NRB) which is currently £325,000 (2024/25), and frozen until April 2030.

Case Study

Mrs Smith is single, 75 years of age and has £1.5million available to invest. She requires a regular income from these funds to meet her expenditure. She has two children, and she wants these funds to be passed to each of them in an equal share on her death. She already makes use of her £3,000 annual gifting exemption each year.