What is the difference between a trust and a bare trust?

If you’re a medical professional considering setting up a trust for your assets, it’s important to understand the differences between a bare trust and a trust. In this article, we’ll provide an overview of these two types of trusts, including their advantages, disadvantages, tax implications, and examples of when they’re best used.

What is a Traditional Trust (Discretionary Trust)

A traditional trust, also known as a discretionary trust, is a legal structure that allows you to transfer assets to a trustee who then manages those assets on behalf of the trust’s beneficiaries. The trustee has discretion over how to manage the assets and distribute them to the beneficiaries, which can provide some flexibility in terms of tax planning and asset protection.

Advantages of a traditional trust include:

• Asset protection from potential lawsuits or creditors: By setting up a discretionary trust, you can transfer your assets to a trustee who will manage those assets on your behalf. This can provide some protection against legal action or financial claims, as the assets are technically owned by the trust rather than by you personally.
• Flexibility in terms of tax planning: If you have multiple beneficiaries with different income levels, the trustee can distribute income or assets in a way that minimizes the overall tax liability for the trust.
• Distribution of income or assets to beneficiaries based on their income levels: With a discretionary trust, the trustee has discretion over how to manage the assets and distribute them to the beneficiaries. This means that income or assets can be distributed to beneficiaries based on their income levels, which can provide some tax advantages.

Disadvantages of a traditional trust include:

• Complex to set up and administer: A discretionary trust can be more complex to set up and administer than other types of trusts, which can make it more expensive and time-consuming to maintain.
• Higher tax rates for retained income: If income is retained in the trust rather than distributed to beneficiaries, it can be subject to higher tax rates.

When to use a traditional trust:

A traditional trust can be useful if you have multiple beneficiaries with different income levels, as it provides flexibility in terms of tax planning.

For example, if you have three children with varying levels of income, you can distribute income and assets from the trust in a way that minimizes the overall tax liability for the trust.

Tax implications of a traditional trust:

A discretionary trust is subject to income tax on all income it earns, but it can distribute income to beneficiaries to take advantage of their lower tax rates.

A discretionary trust can also be subject to capital gains tax when assets are sold, but it can take advantage of the 50% discount on capital gains tax if the asset has been held for at least 12 months.

What is a Bare Trust (Nominee Trust)

A bare trust, also known as a nominee trust, is a type of trust where the beneficiary has immediate ownership of the trust’s assets and income as soon as they are transferred to the trustee. The trustee’s role is simply to hold the assets and distribute them to the beneficiary as required. This type of trust can be useful if you want to transfer assets to a beneficiary without losing control over them.

Advantages of a bare trust include:

• Immediate ownership and control over assets for beneficiaries: With a bare trust, the beneficiary has immediate ownership and control over the trust’s assets and income as soon as they are transferred to the trustee.

 This can be useful if you want to transfer assets to a beneficiary without losing control over them.

• Protection of assets from potential creditors or legal claims: Assets held in a bare trust are technically owned by the trust and not by the beneficiary, which can provide some protection against legal action or financial claims.

Disadvantages of a bare trust include:

• Limited flexibility: With a bare trust, the beneficiary has immediate ownership and control over the trust’s assets, which means that there is little flexibility in terms of tax planning or distribution of income or assets.
• No protection against potential legal claims or creditors of the beneficiary: Because the beneficiary has immediate ownership of the trust’s assets, those assets are vulnerable to potential legal claims or creditors of the beneficiary.

When to use a bare trust:

A bare trust can be useful if you want to transfer assets to a beneficiary without losing control over them, or if you want to ensure that the beneficiary has immediate access to the assets. For example, if you want to transfer ownership of a property to your child but still retain control over it, you can set up a bare trust where you act as the trustee and your child is the beneficiary.

Tax implications of a bare trust:

A bare trust is not subject to income tax, as the beneficiary is the owner of the assets and income as soon as they are transferred to the trust.However, if the beneficiary is a minor, any income earned on the assets will be subject to penalty rates of tax until the beneficiary turns 18.

In summary, both traditional trusts and bare trusts have their advantages and disadvantages, and ultimately, the type of trust you choose will depend on your individual circumstances and goals. It’s important to work with a qualified accountant or financial advisor to ensure that you choose the right type of trust for your needs and that you understand the tax implications involved.

If you’re considering setting up a trust, it’s always a good idea to seek the advice of an experienced accountant or financial advisor who can help you choose the right structure and navigate the legal and tax implications. With the right guidance, a trust can be a powerful tool for protecting and managing your assets. Reach out to Aero Accounting Group and let our expert accountants guide you to setting up your trusts correctly.