What Is a Trust Fund?
A trust fund is an estate planning tool that holds property or assets for a person or an organization. Trust funds are sometimes simply referred to as "trusts." They can hold a variety of assets such as money, real property, stocks, bonds, a business, or a combination of many types of properties or assets.
Establishing a trust fund involves multiple parties: the grantor, the beneficiary or beneficiaries, and the trustee. Trust funds can have more than one beneficiary. They're managed by the trustee who has a fiduciary duty to act in the best interests of the grantor and beneficiaries.
Trust funds can take many forms and they can be established with different stipulations. They can be revocable or irrevocable. Some offer tax benefits and financial protections as well as support for those involved.
Key Takeaways
- A trust fund is a legal entity designed to hold and manage assets on someone's behalf, usually with the help of a neutral third party.
- Trust fund parties include a grantor, beneficiary or beneficiaries, and a trustee.
- The grantor who creates the trust fund sets the terms for how assets are to be held, gathered, and distributed.
- The trustee manages the fund's assets and executes the grantor's directives. The beneficiary receives the assets or other benefits from the fund.
- Trust funds can be revocable or irrevocable and several variations can exist within these categories for specific purposes.
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How Trust Funds Work
Estate planning is a process that involves determining how an individual's assets and other financial affairs will be managed and how any property they own will be distributed after they die. Property can include any bank accounts, investments, personal property, real estate, and/or life insurance. Wills are the most common estate planning tool but trust funds are also popular legal entities. Laws governing trust funds can vary depending on the country of residency and creation.
The following parties are involved in establishing a trust:
- The grantor who sets up the trust and funds it with their assets
- The beneficiaries or person for whom the assets are managed
- The trustee, a neutral third party such as an individual, a bank, or another professional fiduciary who's charged with managing the trust assets
The grantor generally creates an inheritance arrangement that's carried out after they're no longer mentally competent or alive. As the appointed fiduciary, the trustee is responsible for carrying out the interests and wishes of the grantor. This can include allocating living expenses or even educational expenses such as private school or college expenses and/or paying a lump sum or transferring property to the beneficiary or beneficiaries after death.
Trust funds provide certain benefits and protections for those who create them and their beneficiaries.
- Irrevocable trusts can protect assets from creditors in the event they decide to pursue the grantor for unpaid debts.
- Trusts avoid the need for probate after the grantor's death, which is necessary to distribute a decedent's property when they leave a last will or have no estate plan at all.
- Irrevocable trust funds can reduce or eliminate the amount of estate taxes owed after the grantor dies.
- Trusts can be named as the beneficiary of an individual retirement account(IRA)but they'll be subject to accelerated withdrawal requirements and short-circuit spousal inheritance provisions.
Revocable Trust Funds vs. Irrevocable Trust Funds
All trust funds are either revocable or irrevocable. Both are referred to as "living" trusts when the grantor creates them during their lifetime. A "testamentary" trust is one that's created after the grantor's death, usually under terms left in a last will. It's irrevocable because the grantor is no longer living to make changes to it.
Revocable Trust Fund
The grantor can change the terms of a revocable trust at any time or even dissolve and undo the trust completely if they choose. Assets funded or placed into a revocable trust can be transferred to any number of designated beneficiaries after the grantor's death or even during their lifetime.
The primary benefit of a revocable trust is that the assets avoid probate after the grantor's death. This leads to the quick distribution of assets to the named beneficiaries. The terms of a revocable trust aren't made public like those of a last will so an estate can be distributed with a high level of privacy.
Grantors can act as their own trustees when they form a revocable trust or they can appoint someone else to the role. They can name a successor trustee to take over management of the revocable trust after their death when the assets are typically distributed to beneficiaries and the revocable trust is dissolved.
Irrevocable Trust Fund
An irrevocable trust fund is very difficult if not impossible to change or dissolve. Undoing it or its terms typically requires the unanimous consent of all beneficiaries.
This makes them virtually immune to estate taxes and creditor claims. The grantor of a revocable trust can take back assets they've placed into the trust at any time so they're still considered to personally own them. This isn't the case with an irrevocable trust. The grantor permanently gives up control and ownership of the assets and money placed into the trust although they set the terms as to the beneficiaries who will receive them and when.
Types of Trust Funds
Several types of trust funds are included under the umbrellas of revocable and irrevocable trusts. They often have different rules and stipulations depending on the assets involved and the beneficiaries. A tax or a trust attorney may be your best resource for understanding the intricacies of each of these vehicles. This isn't an exhaustive list.
- Asset Protection: This type of fund protects a person's assets from their creditors' future claims. Only an irrevocable trust can serve this purpose.
- Blind: This trust attempts to remove any hint of conflict of interest. The trust fund's grantor and beneficiaries have no knowledge of how the holdings are managed. The trustee has total control.
- Charitable: A charitable trust fund can benefit a particular charity or the general public.This includes a Charitable Remainder Annuity Trust (CRAT) that pays a fixed amount each year.A Charitable Remainder Unitrust passes assets to a specified charity when the fund expires and gives the donor a charitable deduction as well as a fixed percentageof income to the beneficiary during the life of the trust fund.
- Generation-Skipping: This one provides tax benefits when the beneficiaries are the grantor’s grandchildren or anyone who's at least 37½ years younger than the grantor.
- Grantor Retained Annuity: Establishing this type of fund allows the grantor to transfer any appreciation of assets to any beneficiaries to minimize estate taxes.
- Individual Retirement Account: Trustees control IRA distributions rather than the beneficiaries.
- Land: This allows for the management of property, such as land, a home, or another type of real estate.
- Marital: This is funded at one spouse's death and is eligible for the unlimited marital deduction.
- Medicaid: Designed to allow individuals to set aside assets as gifts to their beneficiaries, this allows the grantor to qualify for long-term care under Medicaid. It's irrevocable.
- Qualified Personal Residence: An individual can move their residence from their estate to this type of fund to reduce the amount of gift tax incurred.
- Qualified Terminable Interest Property: This one benefits a surviving spouse but allows the grantor to make decisions after the surviving spouse’s passing.
- Special Needs: People who receive government benefits are the beneficiaries of this type of trust. The trust provides financial support in such a way so as not to disqualify them from government benefits. Some strict rules apply. A special needs trust must also be irrevocable.
- Spendthrift: Beneficiaries' access to assets is limited with this type of trust. Money and assets are released to them incrementally. The trustee is granted discretion as to when to transfer inheritances to them and how much. This safeguards against the beneficiaries' creditors and/or their bad spending habits.
Special Considerations
Wealth and family arrangements can grow quite complicated when a great deal of money is at stake for multiple generations of a family or another entity. A trust fund can include a surprisingly complex array of options and specifications as a result.
Trust funds aren't just for the ultra-rich, contrary to what some people believe. Anyone can use them regardless of their financial situation. Discuss your needs with a financial or legal professional to find out what kind of fund is well-suited for you.
What Is a Trust Fund Baby?
A trust fund baby is someone whose parents have set up a trust fund for them. The term is a popular cultural reference that's often used negatively. There's an implication that these beneficiaries are born with silver spoons in their mouths, are overly privileged, and don't have to work to earn a living.
Trust funds can indeed provide beneficiaries with security but many so-called trust fund babies don't live luxuriously or in high society.
How Do Trust Funds Work?
A trust fund is a legal entity that holds property and assets and can provide financial, tax, and legal protections. A grantor sets it up and funds it with money or assets. One or more beneficiaries receive the assets under specified terms. The trustee manages the trust and distributes its assets at a prescribed time.
The trustee is in charge of managing the assets in an irrevocable trust while the grantor is still alive. The trustee can pass the assets on to the beneficiary or beneficiaries per the grantor's instructions after the grantor's death under the trust terms that the grantor has set.
Grantors often act as trustees of their revocable trusts. They name successor trustees to take over management and dissolution of the trust when they die.
How Do I Start a Trust Fund?
You'll first have to figure out which type of trust is best suited for you. Then decide how you'll fund it. Figure out who you want to appoint as your trustee or successor trustee. The final step is to fund the trust.
Be sure a trust fund is the best choice for you, your beneficiary, and your financial situation. Seek legal help to set up the proper documents so you're sure the trust will serve the purpose you intend and its terms will be honored by the court.
The Bottom Line
A trust fund is a living or testamentary trust that’s set up to hold and manage assets on behalf of its beneficiaries. It can be either revocable or irrevocable depending on the purposes you want it to serve and how much control you're willing to relinquish. Both types of trusts avoid probate but only irrevocable trusts can dodge estate taxes and avoid creditor claims.
Trust funds can serve a multitude of purposes. Your best bet is to consult with a legal professional if you think one might be right for you. A professional can guide you to what type of trust will most fully meet your needs. They can ensure that the formation documents are created properly so they’ll achieve your goals and hold up in court should anyone contest the trust’s terms.
