Bare Trust vs. Discretionary Trust
Where to place your Discounted Gift 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 Settlor’s Nil Rate Band (NRB) which is currently £325,000 (2026/27), and frozen until April 2031. It is also worth noting that a Discretionary Trust is subject to a periodic IHT charge every 10 years and a proportionate charge when assets leave the Trust. These charges do not apply to a Bare Trust.
Case study
Mrs Smith is single, 75 years of age and has £1.5 million 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.
| DGT in a Discretionary Trust | DGT in a Bare Trust |
| Mrs Smith can pay a maximum of c.£570,000 into a DGT within a Discretionary Trust, with a withdrawal rate of up to 5%, before it would trigger an immediate IHT liability. | Mrs Smith could pay the full £1.5 million into a DGT within a Bare Trust, with a withdrawal rate of up to 5%, without an immediate IHT liability. |
| Who benefits from the Trust on the settlor's death is at the discretion of the Trustees. We have assumed that there would be an immediate discount to the estate of c.43% which amounts to c.£245,000. This immediately reduces IHT by c.£98,000. | Mrs Smith would have to specify exactly who is to benefit from the Trust after her death at the outset and in what proportion, and this cannot be changed. We have assumed that there would be an immediate discount to the estate of c.43% which amounts to c.£645,000. This immediately reduces IHT by c.£258,000. |
| The remaining c.£325,000 is classed as a CLT gift that would fall within Mrs Smith's NRB*. If Mrs Smith survives seven years from the point of the gift, the gift will not be subject to IHT, saving a further £130,000. | The remaining c.£855,000 is classed as a PET gift. If Mrs Smith survives seven years from the point of the gift, the gift will not be subject to IHT, saving a further £342,000. |
*Any CLTs above the NRB are charged at 20%.
Conclusion
If the settlor/owner of the Trust knows exactly who they want to pass the funds on to after their death and are certain that this will not change, then a Bare Trust could be a suitable option. As well as removing the restriction on gift size, there are no 10-year or exit charges to consider, which is another factor worth weighing alongside the flexibility question.
The tax treatment described in this article depends on the individual circumstances of each client and may be subject to change in the future.
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