Definition
The term naked trust refers to an estate planning tool that allows the grantor, or settlor, to efficiently transfer assets to their heirs. The only responsibility of a naked trust's trustee is to transfer assets to the beneficiaries.
Explanation
Also referred to as a bare trust or dry trust, a naked trust is typically used to pass assets to minor children or grandchildren. Essentially, the trust's donor is setting aside assets that will be provided to the beneficiary when they reach age 18. With a naked trust, the trustee's only responsibility is to pass the assets onto the trust's beneficiaries. This contrasts with most trusts, where the trustee is also responsible for investing the assets on behalf of the beneficiary.
Naked trusts are considered an estate planning tool, and they are frequently used to pass assets to heirs when they become adults. One important downside of these trusts involves financial aid if the beneficiary eventually goes to college. Since the federal financial aid guidelines capture a higher percentage of the student's assets than a parent's, a large transfer of wealth to the student at age 18 will lower their chance of receiving any type of financial aid.
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