✅ FAQ: Lifetime Trusts – VPT vs. Bare Trust vs. Discretionary Trust

 

1. What is a Lifetime Trust?

A lifetime trust is a legal arrangement where assets are transferred by the settlor into a trust during their lifetime, to be managed by trustees for the benefit of beneficiaries.
Unlike a Will trust, which comes into effect only on death, a lifetime trust is active immediately.

2. What Are the Main Types of Lifetime Trusts?

  • Vulnerable Person’s Trust (VPT): For disabled or vulnerable beneficiaries (as defined by HMRC).

  • Bare Trust: The beneficiary has an absolute right to both income and capital (i.e., the beneficiary can demand the trust assets at any time once of legal age, and the trustees have no discretion).

  • Discretionary Trust: Trustees have full discretion over how and when beneficiaries receive income or capital.

3. What Are the Tax Benefits of a VPT?

  • No 20% entry charge, even if value exceeds the £325,000 nil-rate band (if Section 89 conditions are met).

  • No 10-year or exit charges (unlike discretionary trusts).

  • Income tax and CGT are usually charged at the beneficiary’s personal rates (often lower).

✅ Best for: Protecting a disabled or vulnerable person while minimising IHT and income tax.

4. What Are the Benefits of a Bare Trust?

  • Treated as a Potentially Exempt Transfer (PET) – No IHT if the settlor survives 7 years.

  • Beneficiary has an absolute and fixed entitlement (cannot be altered).

  • Simple to set up and run – no ongoing trustee decisions required.

✅ Best for: Gifting assets to a specific person (e.g., children or grandchildren) with IHT efficiency.

5. What Are the Downsides of a Discretionary Trust?

  • 20% lifetime IHT charge on transfers over the nil-rate band (no PET treatment).

  • 10-year periodic charges (up to 6% on value over the NRB).

  • Exit charges when funds are distributed.

  • Higher income tax (up to 45%) and CGT (28%) on trust income and gains.

✅ Best for: Retaining control over how wealth is used across future generations.

6. Is a Discretionary Trust Worth It vs. VPT or Bare Trust?

  • ❌ No, if your main goal is IHT efficiency – VPTs and Bare Trusts are better.

  • ✅ Yes, if your priority is flexibility, control, and asset protection.

7. Can a Discretionary Trust Qualify for PET?

❌ No – PETs only apply to outright gifts, such as to individuals or into bare trusts.

➡️ Discretionary trusts are treated as Chargeable Lifetime Transfers (CLTs) and subject to the 20% IHT entry charge if over the NRB.


8. Is a Discretionary Trust Worth It?

Yes – but only if:

  • You need flexibility to delay/control distribution.

  • You're comfortable with tax costs (or plan to stay within the NRB).

  • You want protection from marital claims, creditors, or spendthrift risks.

10. What’s the Best Way to Avoid IHT?

  • Use a VPT if the beneficiary qualifies (Section 89-compliant).

  • Use a Bare Trust for simple PET-based gifting (survive 7 years).

  • Consider Business Property Relief (BPR) or Agricultural Property Relief (APR) for qualifying assets



Case Study: Comparing VPT, Bare Trust & Discretionary Trust for a £500,000 Transfer

Scenario

  • Settlor: John, a UK resident, wants to transfer £500,000 to benefit his family.

  • Beneficiaries:

    • His disabled son (qualifies for a Vulnerable Person’s Trust).

    • His adult daughter (could use a bare trust).

    • His grandchildren (may need a discretionary trust for flexibility).

We compare the tax efficiency, control, and long-term implications of each trust.

Option 1: Vulnerable Person’s Trust (VPT)

✅ Best for: John’s disabled son

Key Features

  • No upfront IHT (if within allowances or qualifying disabled trust rules).

  • No 10-year/exit charges (unlike discretionary trusts).

  • Income & capital gains taxed at son’s lower rates (if he has no other income).

Tax Implications

Tax TypeVPT Treatment
Inheritance Tax (IHT)No immediate charge (PET-like if conditions met).
Income TaxTaxed at son’s rate (e.g., 0% if under allowance).
Capital Gains Tax (CGT)Son’s personal allowance (£6,000 in 2023/24).

Pros

✔ Massive IHT savings (vs. discretionary trust).
✔ Lower ongoing taxes (income & CGT at beneficiary’s rate).

Cons

✖ Only for disabled/vulnerable beneficiaries.
✖ Limited flexibility (must be used for son’s benefit).

Option 2: Bare Trust

✅ Best for: John’s adult daughter

Key Features

  • Legally owned by the beneficiary (daughter has absolute right).

  • Treated as a Potentially Exempt Transfer (PET) – No IHT if John survives 7 years.

Tax Implications

Tax TypeBare Trust Treatment
Inheritance Tax (IHT)PET – 0% if John survives 7 years.
Income TaxDaughter’s personal rate.
Capital Gains Tax (CGT)Daughter’s allowance.

Pros

✔ No IHT if John lives 7+ years.
✔ Simple & cheap to set up.
✔ No ongoing trust taxes (treated as daughter’s asset).

Cons

✖ No control (daughter can access funds at 18+).
✖ Not suitable if John wants restrictions.

Option 3: Discretionary Trust

✅ Best for: Grandchildren (flexible control)

Key Features

  • Trustees decide who benefits & when.

  • 20% IHT charge on amount over £325,000 (£35,000 tax on £500k transfer).

  • 10-year charges (up to 6%) & exit charges apply.

Tax Implications

Tax TypeDiscretionary Trust Treatment
Inheritance Tax (IHT)20% on £175k (£35k tax due now).
Income Tax45% (dividends: 39.35%).
Capital Gains Tax (CGT)28% (if over £3,000 exemption).

Pros

✔ Full control over distributions.
✔ Protects against divorces/bankruptcies.

Cons

✖ £35,000 IHT bill upfront.
✖ Ongoing 10-year charges (up to 6%).
✖ Higher income & CGT rates.

Summary: Which is Best for £500k?

Trust TypeIHT Due Now?Ongoing TaxesFlexibilityBest For
VPT£0 (if conditions met)Low (beneficiary’s rate)LimitedDisabled beneficiaries
Bare Trust£0 (if PET applies)None (beneficiary owns it)NoneSimple gifts (children)
Discretionary Trust£35k (20% on £175k)High (45% income, 28% CGT)Full controlFamily wealth protection

Final Recommendation

  • If beneficiary is disabled → VPT (best tax savings).

  • If making an outright gift → Bare Trust (PET advantage).

  • If needing control & willing to pay tax → Discretionary Trust.

Next Steps:

  • If John wants IHT efficiency, use VPT (for son) + Bare Trust (for daughter).

  • If he needs flexibility for grandchildren, a discretionary trust may be worth the tax cost.



🔍 How FLIT compares to other trusts for protection

Trust TypeDivorce/Creditor ProtectionControlTax Efficiency
Bare Trust❌ No (beneficiary owns asset)❌ None✅ High (PET)
Discretionary Trust✅ Strong✅ Full❌ Costly (20% entry + 10-year charges)
FLIT✅ Strong (esp. capital)✅ Medium✅ Good (if via Will)
VPT✅ Good (protected for disabled person)❌ Limited✅ Excellent (no IHT if qualifies)

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