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What is an absolute trust?

An absolute trust, or bare trust as they are also known, is an arrangement whereby a settlor gives trustees cash or other assets to look after for a named beneficiary (or beneficiaries). The main difference from other types of trust is that the beneficiary(ies) cannot be changed.

Settlors must therefore be certain of who they wish to benefit from the outset. If they're not, then other types of trust, such as a discretionary or an interest in possession trust may be more appropriate.

Reasons for using an absolute trust

Absolute trusts may be used for gifts made during lifetime using a trust deed, or on death via a will. There are several reasons why a settlor may choose this route:

• the settlor is certain of who they wish to benefit
• to make gifts to minor children
• to make gifts to adults who are unable or not trusted to manage their own affairs (but be aware of an adult beneficiary’s right to demand the trust assets)
• to ensure that a lifetime gift is a potentially exempt transfer and won't be subject to an immediate IHT charge

Rights to the trust fund

The beneficiary is entitled to the trust fund and any income from it and, from the age of 18 (16 in Scotland), can demand that the trustees transfer the assets to them. If trustees continue to hold assets beyond these ages, they should make the beneficiaries aware of their entitlement as they will need to know for tax purposes, or in other financial situations such as divorce or bankruptcy. An absolute trust won't normally protect a beneficiary from creditors.

Should the beneficiary of an absolute trust die, their share will pass to the beneficiaries chosen in their own will or, if they have no will, then according to the intestacy rules. Their share does not pass to any surviving beneficiaries of the original trust, nor does the settlor have any say over who they go to. 

Administration issues

Having created an absolute trust, the trustees will deal with the administration of the investment as ‘legal’ owners, e.g. if they invest in a life assurance bond, they will deal with the product provider. It's likely they will also have wide investment powers, but these must be used in the best interests of the beneficiary. Any income that arises from investments belongs to the beneficiary and should be paid to them, unless they are minors, in which case they may hold the income for them until they reach the age of 18 (16 Scotland).

The trust may also allow the trustees to use the trust fund, and any income they hold, for the benefit of a beneficiary. This can be particularly useful for minors, e.g. to use for their education.

The scope of the TRS has been widened to comply with the 5th Money Laundering Directive (5MLD) and most trusts will have to register regardless of whether there is a tax liability, unless specifically exempt. Absolute or ('bare') trusts are not exempt and must be registered.

Inheritance tax

On creation of trust

Gifts into absolute trusts are treated as potentially exempt transfers (PET). There will be no immediate IHT charge, and they will escape IHT altogether provided the settlor (or donor) survives the gift by seven years.

In the case of joint settlors, each is treated as having made a PET of the value of their respective contribution. Where the funds are provided from jointly owned assets the transfer is deemed to be split equally unless it can be shown otherwise.

If the settlor does die within seven years, the gift will become a chargeable transfer which may result in IHT payable by the beneficiaries. The IHT nil rate band available to the remaining estate of the settlor may also be less.

During life of trust

During the time that the trustees hold the trust assets, there will be no IHT charges on the trust itself. This is because the trust is not a ‘relevant property trust’, and  therefore not subject to 10 yearly periodic charges, or exit charges when assets are ultimately transferred to beneficiaries.    

Although there are no exit charges when the trustees transfer assets to a beneficiary, the value of the trust will always be included in the estate of the beneficiary for IHT from the moment the trust is created.

Income tax

Interest and dividends

As the income from the trust investments belongs to the beneficiary, it is also taxed as their income. This means beneficiaries can use their own allowances and rates (personal allowance, 0% starting rate band for savings, personal savings allowance and dividend allowance).

The exception to this is when a parent makes a gift into absolute trust for the benefit of their minor, unmarried, child. If the trust produces income over £100 a year, all of this income will be taxed on that parent. This is known as the ‘parental settlement’ rule, and is applied per parent, per child.

Investment Bonds

Investment bonds don't produce income, and there's no income tax charge unless money is withdrawn from the policy and a chargeable event occurs. The investments within the bond wrapper can be reviewed and changed  without the need for self-assessment returns to be completed.

This can be ideal for a parent gifting money in an absolute trust for their minor child because income tax can be deferred until the child reaches 18, from which point gains will be taxed on them. If a withdrawal is needed before the child is 18, for example to pay education fees, should the gain exceed £100 a year, the parental settlement rule will apply and the whole gain will be taxed on the parent.

The parental settlement rules do not apply if the settlor is say a grandparent or another family member so any chargeable gain on the bond can be assessed on the minor child. 

CGT 

On creation of the trust

Absolute trusts can be created by either the transfer of cash to the trustees, or by the transfer of an actual asset, such as an existing insurance bond or portfolio of shares/mutual funds.

There are no capital gains tax consequences for lifetime gifts involving cash or existing bonds. However, if other assets are transferred into trust while the settlor is still alive, this will be a disposal for CGT with any gain being assessed on the settlor.

Assets transferred to trust on the settlor’s death won't normally have been subject to CGT. The trustees will have acquired the assets at their market value at the date of death. 

Gift hold-over relief normally won't apply to transfers to absolute trusts unless the transfer is a gift of business assets.

During the life of the trust

Any capital gains arising on the disposal of an asset under an absolute trust is assessed on the beneficiary, not on the trust. Beneficiaries can use their own annual capital gains tax exemption. This is the case even if the settlor is a parent and the trust is for the settlor's own minor, unmarried child. In other words, there's no CGT equivalent of the parental settlement anti-avoidance rule that exists for income tax.

Transfer out of trust

Transfers of assets out of an absolute trust to a beneficiary, for example, upon reaching the age of majority, are ignored for CGT purposes.