WHAT IS A TRUST FUND? How Does It Work?

What is a Trust Fund

There are numerous options for providing a financially secure future for your loved ones. Trust funds are an excellent approach to prepare your children or grandkids for financial success in the future. Furthermore, they aren’t generally reserved for the exceedingly rich. In reality, regardless of your net worth, you can establish a trust fund to ensure that your loved ones manage and distribute your assets in a precise manner. Consider engaging with a financial expert for assistance with trust funds or other estate planning difficulties.

What Is a Trust Fund?

A trust fund is a legal institution that keeps assets until its intended recipient can receive them. When the beneficiary reaches a specific age or when the prior owner of the assets dies, this occurs.

It is helpful to grasp the following three terms in order to comprehend how a trust fund works:

  • Grantor: This is the individual in charge of transferring assets to a trust fund. If you’re the one wanting to establish a trust, that’s you.
  • Beneficiary: A beneficiary is someone who has the legal right to assets in a trust fund. That might be family or a favorite charity.
  • Trustee: The trustee is the decisionmaker in charge of ensuring that the assets in the trust fund are dispersed properly.

Trusts can hold assets such as real estate (such as heirlooms or jewelry), stocks, bonds, or even enterprises.

Cars and life insurance should not be placed in a trust without first speaking with a tax professional or an estate attorney. Retirement accounts, for example, should not be placed in a trust because they usually already have a nominated beneficiary, keeping them out of probate, the sometimes lengthy legal process of confirming a will, and distributing assets according to its instructions.

There are two ways to transfer assets into a trust fund. As a grantor, you can either transfer assets into a trust fund while you are living or use your estate plan to specify that a trust fund be established and certain assets are transferred to it when you die.

How does a Trust Fund Work

Trust funds can contain a variety of assets, including cash, investments, real estate, and artwork. They can even hold entire businesses. Basically, anything valuable can be placed in a trust fund.

Trust funds, thus, are “entities.” What does that entail in terms of understanding how trust funds work?

Putting money in a trust allows you to convey property to someone in an organized manner where regulations can be imposed. For example, you could state that the beneficiary is not permitted to use the funds to pay off debts. Alternatively, you could place restrictions on how old the beneficiary must be before she can obtain possession of the funds.

Reasons to Establish a Trust Fund

Although there are countless reasons for establishing a trust fund, here are some of the most common—as well as the types of trusts best suited to them.

#1. Probate is avoided.

Assets in a trust fund are distributed to beneficiaries outside of the probate process. You could set up a revocable living trust for this purpose.

#2. Beneficiaries are being safeguarded.

If a beneficiary lacks the life skills required to manage the trust’s assets (for example, a minor inheriting a large sum of money), you can set up a contingent trust that delivers assets to them only when they reach a specific age.

#3. Keeping valuables safe.

If you wish to secure some assets for your children in the event of a divorce, you might set up a spendthrift trust to ensure that your child’s former spouse has no claim to the trust assets.

#4. Establishing a line of descent.

You might set up a spousal trust, also known as a bypass, credit shelter, family, or A/B trust if you want your surviving spouse to acquire assets in the trust first and then distribute the remaining assets to chosen beneficiaries when they die.

#5. Taxation.

You can transfer assets into an irrevocable trust to decrease your tax liability or prevent potential estate tax. Because the assets in this type of trust are no longer held by you, you will not have to pay income taxes on them during your lifetime, and you may avoid estate taxes when you die.

#6. Making provisions for a disabled beneficiary.

Certain social services are only available to people with low net worth and income. You can set up a supplemental needs or special needs trust to ensure that a disabled person in your care continues to receive government assistance after you die, even if they inherit money.

Most trust funds are also classified as either revocable or irrevocable.

Revocable trust funds enable the grantor to change or revoke the trust during his or her lifetime. Irrevocable trust funds are permanent and normally cannot be easily changed after they are established.

The Advantages and Disadvantages of Trust Funds

Each type of trust fund has advantages and disadvantages. Here’s how they differ between the two types of trust funds: revocable and irrevocable trusts.

The Advantages of Revocable Trust Funds

#1. Asset administration.

Revocable trusts allow for simple asset administration and control, which can be quite beneficial for elderly people with children who live in distant cities. Because assets transferred to a trust must be titled in the trust’s name, the trust can consolidate a diverse range of assets under a single umbrella, and when the grantor dies, the assets can be controlled by a trustee.

#2. Keeping Probate at bay.

If you live in a state where probate costs are high and probate times are long, assets held in trust can easily pass to your heirs and save them from having to wait for the state to settle your estate.

#3. Privacy.

A revocable trust allows you to keep your property ownership private. Consider trust names that disguise personal information, such as the JJS Revocable Trust rather than the John James Smith Revocable Trust, to keep things secret.

The Disadvantages of Revocable Trust Funds

#1. Expensive

The fees of establishing a revocable trust vary depending on the complexity of your estate and the state in which you live. Legal fees, asset retitling fees, tax filing fees, and trustee fees, among other things, could be expected.

#2. Extra complication.

Many people choose to set up a revocable trust in order to avoid probate after they die. However, if they do not keep track of any new asset acquisitions, their heirs may still have to go through probate. One useful piece of advice is to have your estate planning attorney contact you on a frequent basis to remind you that if you buy new titled assets, make sure the revocable trust has that title.

#3. This is not a replacement for an estate plan.

A trust does not take the place of estate planning. It is, however, one component of a comprehensive estate plan that can potentially play a role in your tax strategy.

#4. Having confidence in your trustees.

Naming a trustee, like naming an executor in your will, is not a duty to be taken lightly. To have peace of mind that the assets in your trust will be managed ethically and distributed as you wish, you must have a high level of trust in the person you name as trustee.

In general, all of the benefits—and drawbacks—of revocable trusts apply to irrevocable trusts, as well as a few additional benefits and drawbacks.

Advantages of Irrevocable Trust Funds

#1. Tax administration.

People frequently create irrevocable trusts to deduct assets from their net worth and reduce future estate taxes. Furthermore, because assets are no longer titled in a person’s name, they may be able to lower their tax liability while still alive.

#2. Wealth distribution in a responsible manner.

An irrevocable trust can be used to educate youngsters on appropriate wealth management. An irrevocable trust, for example, could require beneficiaries to meet specific conditions (such as attending college or working) in order to receive benefits.

#3. Asset safeguarding

Because the assets in your trust are no longer held in your name, an irrevocable trust can protect your assets from litigation.

The Downsides of Irrevocable Trust Funds

Permanence.

The most significant disadvantage of irrevocable trusts is that they are permanent. Some state laws may allow for minor changes once an asset is placed in an irrevocable trust, but don’t bank on it. Because of the irrevocable trust’s permanence, many grantors are hesitant to use it and reap all of its benefits.

A Will vs. a Trust Fund

A trust does not, in any way, substitute a will. You can only name an executor and legal guardian for your children through a will. In the absence of a will, the state in which you reside will split your property and assets as it deems fit.

A will, in fact, is the most critical component of your estate strategy.

Having said that, having a will and a trust can assist ensure that your money not only goes to those you want but also goes in the way you want.

Because wills are subject to probate, you may want to set up a trust once you have one. This means that creditors, other relatives, or even your children may contest what it says during the probate procedure.

For example, suppose your will leaves 40% of your estate to your son, 40% to your daughter, and 20% to charity. Your children have the legal right to contest the will and try to stop the charity. Alternatively, if your daughter believes she is entitled to more than 40%, she can sue your son.

While more difficult to set up, a trust can avoid the probate process in the long run.

Can a Trustee Take Money Out of a Trust?

When considering trust funds, many people are concerned that a trustee will raid the trust for personal gain. To be clear, this is against the law. Specific rules differ depending on where you live, but a trustee may never remove funds for personal purposes. Because the trustee has a fiduciary responsibility, he or she is obligated to behave in the best financial interest of the beneficiary and must abide by the regulations and provisions of the trust agreement.
The trustee is the only person (or persons) who can withdraw funds from a trust account.

Types of Trust Funds

You have options in this area, as in many others in financial planning.

#1. An Irrevocable Trust Fund

As the name implies, this type of trust cannot be modified or destroyed later. Once assets are placed in a trust, they are no longer yours. A trustee is in charge of them. This can include a bank, an attorney, or another institution established up specifically for this purpose.

The good news is… Because the assets are no longer in your immediate control, you are exempt from paying income or estate taxes on any interest earned from them.

An irrevocable trust, on the other hand, would shield your assets from creditors or lawsuits. If you set up an irrevocable trust to donate your assets to charity, you can deduct the value of those assets from your taxable income.

Another advantage of an irrevocable trust is that the money is protected from nursing homes because it is “no longer yours.” If you require long-term care, this money will not be depleted by an expensive facility. However, if you place a large portion of your assets in an irrevocable trust, you may not have enough money to cover your living expenses in the future!

While there are advantages to creating an irrevocable trust, the most significant disadvantage is that no changes can be made. Even if you really need the money, you can’t get it “back” later.

#2. Revocable Trust Fund

As you might have guessed from the name, this is the inverse of an irrevocable trust. You can revoke it at any time and make changes. These trusts, often known as “living trusts,” take effect while you are still alive.

Of course, you don’t get the same tax advantages as an irrevocable trust, but you have a lot more flexibility. This type of trust still allows you to specify who and how your assets should be inherited.

You can also layout expectations for a future trustee. For example, if you are concerned about becoming physically or mentally incapacitated, you could manage your own assets while having a trustee ready to step in if necessary.

#3. Special Needs Trust Fund

If you have a special needs child, you should think about establishing a trust fund. Even if you die unexpectedly, you can help guarantee he receives specialized care by establishing a trust.

You can name the special needs trust as the beneficiary of your life insurance policy rather than the dependent. This has a few benefits. First, if your dependent is incapable of managing money, it deputizes someone else to do it. Furthermore, naming the trust as the beneficiary may allow you to continue receiving as many government benefits as feasible.

(If you’re caring for someone with special needs, you’ll probably want to engage with a special needs estate planning attorney.)

#4. Charitable Remainder Trusts

These types of trust funds may be able to save money on taxes while also donating to a charity that you care about. With a charitable remainder trust, you can donate your assets to a charity that will act as a trustee and manage those assets while you are still living. When your investments earn a profit, the charity will give you (or another beneficiary) the revenues. This would continue for a set amount of time, often for the grantor’s entire life.

In other words, you might “pre-gift” a charitable contribution now to gain an immediate tax benefit while also protecting your assets from estate taxes by reducing the size of your estate when you die (at which time the funds would belong to the charity in full).

#5. Testamentary Trusts

Testamentary—similar to a last will and testament. You can set up a testamentary trust in your will to manage what happens to your assets and how your property is inherited. If you take this method, the probate court will review your will after you die. If you specified that trusts be created through the document, they will take effect once the court confirms your will and agrees to follow the directions you’ve put forth.

#6. Qualified Terminable Interest Trust (QTIP)

This type of trust ensures that the trustor’s spouse can live in their home until he or she dies, but does not allow that spouse to sell the property. This is especially helpful for blended households. Assume you are married and have an adult child from a previous marriage. Let’s say you wish to leave your house to your child when you die. You may utilize a QTIP trust to ensure that your spouse isn’t “kicked out” of the house where you’ve been living together if you die. When your husband died after a certain number of years, your child would be able to receive the house.

#7. Spendthrifts Trusts

This is a wide phrase for trust funds designed to allow the trustee to withhold money from the beneficiary if the trustee suspects the beneficiary would waste it or have it recovered by a creditor. For example, if you wanted to leave money to your children but weren’t convinced they’d be responsible enough to spend it wisely, this could be a good option. Or, for example, if you wished to leave money to someone who suffers from substance abuse or compulsive spending.

#8. Grantor Retained Income Trusts (GRITs)

This type of trust fund is mainly useful for the extremely rich. The goal of this type of trust is to try to lower the amount of money the government values your property for estate tax purposes. If your estate is worth more than a particular amount, you may have to pay estate taxes; this is why GRITs allow the trustor to generate interest income from trust assets while not including the value of that property in the grand total for estate tax purposes.

#9. Qualified Personal Residence Trusts

Qualified personal residence trusts provide a similar purpose to GRITs in that they help decrease your tax liability. These are irrevocable trusts that can be utilized to keep your principal residence or vacation house “out” of your estate for tax reasons. Because it is an irrevocable trust, you cannot retrieve it, but this move can be handy if you want to transfer ownership of a home to family members.

#10. Blind Trust Fund

The beneficiary of a Blind Trust Fund is unaware of the identity of the Trustee, or person in charge. The Trustee of a Blind Trust Fund has the entire responsibility for the management of the Trust until the assets are disbursed.

Blind Trust Funds are often utilized when individual wishes to avoid a conflict of interest, such as when the Trust involves business or investments. Blind Trusts can also be used to add an extra layer of privacy to Trust management.

#11. Unit Trust Fund

A Unit Trust Fund is a type of mutual fund structure that permits earnings to be transferred directly to the client (who would be the beneficiary). Unit Trust Funds enable investors to maximize their dividends while not reinvesting their earnings in the fund.

Unit Trust Funds can invest in a wide range of assets, such as securities, stocks, and bonds. They are most typically used by investors as a tax shelter approach rather than as a tool for estate planning.

#12. Common Trust Fund

A financial institution manages a Common Trust Fund on behalf of a group of persons. Common Trust Funds are similar to mutual funds in certain ways, but their membership is limited to individuals who have Trust accounts.

Common Trust Funds are less commonly employed than they once were because alternative Trust and investment types can provide more benefits. They are now regarded as a specialized investment structure.

#13. Trust Fund Baby

A Trust Fund Baby is someone who, when they reach a particular age, will receive money or assets from a Trust. The formal word for this person is a beneficiary, although in popular culture, “Trust Fund Baby” is widely used. The phrase “Trust Fund Baby” can have negative connotations because it indicates that someone is the beneficiary of hereditary wealth. It is frequently mentioned in television dramas or films.

Why Do Affluent People Use Trust Funds?

Trusts are frequently used by wealthy persons to generate a tax-free estate.

The government sets a limit on how much you can leave to someone without incurring federal gifts or estate taxes. The exemption in 2018 was $11.2 million per taxpayer. So, if you’re really wealthy, a trust fund can be an excellent method to donate money without subjecting your heirs to a large tax.

So, yes, there’s a reason why many people connect trusts with the wealthy. Having said that, there are plenty of applications for the rest of us as well.

How to Set Up a Trust Fund

You’ll need the following information to set up a trust fund:

  • Name of the Trustee
  • The trust’s name
  • The trust’s description, namely why the trustor is creating it
  • Trustee name, as well as any instructions for replacing a trustee if he or she is unable to serve.
  • Name of the Beneficiary
  • A list of the trust fund’s property
  • The trustee’s responsibilities and abilities (for example, whether the trustee can buy or sell property contained in the trust or how the process works if the trustee wants to resign or transfer responsibilities to someone else)
  • What should happen if the trustor, trustee, or beneficiaries died or became incapacitated?

How Much Funding Is Required for a Trust Fund?

Creating a trust is time-consuming and costly. That is why many people become stuck at the “how to set up a trust fund” stage. Many attorneys will charge between $1,000 and $5,000 to set up a new trust. The cost will vary according to where you live and the nuances of your circumstance.

To save money, you might also consider using online preparation services like LegalZoom or Quicken. While this method may be less expensive, if you require legal counsel, you should still speak with a professional attorney. A simple trust fund might be as simple as a few pages of paperwork.

What is the Value of a Trust Fund?

The amount of money in a Trust Fund varies according to the originator of the Trust, the type of Trust, and how much the account has grown since it was founded. In most situations, any interest earned on funds held in a Trust Fund is also distributed to the beneficiary.

There are numerous sorts of Trusts that might allow you to invest your funds before distributing them to the beneficiary. The best option will be determined by your objectives when setting it up.

What is the Average Size of a Trust Fund?

The precise average Trust Fund amount is unknown, but according to the Survey of Consumer Finance, it is roughly $4 million. It should be noted that this figure is based on a 2017 survey of approximately 6,482 families and so may not be a good representation of the full United States. Many people are relieved to learn that Trust Funds provide the benefit of secrecy; however, this also implies that there are no definitive answers on average Trust Fund amounts or frequency of use.

Do Trust Funds Grow in Value?

A trust fund is a vehicle that holds other assets, so no two trust funds are the same. You must place assets or property in a trust fund. So, yes, if the assets in the trust fund grow (for example, investments that grow over time or earn interest).

A trust account is as simple as a bank account, except that the money is owned by a trust rather than an individual. Like other bank accounts, some trust accounts can also earn interest. Generally speaking, this interest is paid to the account beneficiary.

How Long Do Trust Funds Last?

Trusts can last for a long time, but the exact rules tend to vary by state. For example, in many places, the trust can’t keep going more than 21 years after the death of a potential beneficiary who was alive when the trust was set up. That’s called the “rule against perpetuities” and is intended to restrict trusts that could theoretically last forever.

That said, some states like California have made their own related but different laws. In California, for example, there’s a version of the rule that just says that trust can last about 90 years. Delaware lets trust keep going for up to 300 years, though, and some states don’t have any expiration. These neverending trusts are sometimes called “dynasty trusts.” They’re chiefly used by the super-rich because of the tax benefits; you’d only need to pay gift or estate taxes when you transfer money into the trust, but then many subsequent generations would be able to inherit property without paying estate taxes.

Trusts can terminate early if they run out of property, or if the probate court orders it to end. (That’s rare.)

Conclusion

The answer to “what is a Trust Fund” is simple: it’s a way to provide financial support to your loved ones throughout their lives.

A trust fund is a solid estate planning tool for those who want more control over their assets than what a will can provide. Trusts allow the grantor (the person setting up the trust) to establish its terms. This basically involves how and when you want the contents of the trust to go to your beneficiaries. Irrevocable trust funds also provide some tax benefits and protection of their assets from legal action.

Trust funds can be a crucial aspect of people’s estate arrangements. However, you’ll likely need to do much more than that to guarantee your family is taken care of after you’re gone. Check out our guide on estate planning vs. wills to learn more.

Trust Fund FAQ’s

How much money do you need for a trust fund?

A trust may be appropriate for you if you have a net worth of at least $100,000 and a large amount of real estate assets, or if you have extremely specific instructions on how and when you want your estate dispersed to your heirs after you die.

Do trusts earn interest?

A trust account is as easy as a bank account, except that the money is owned by a trust rather than an individual. Some trust accounts, like other bank accounts, can yield interest. In general, this interest is paid to the account beneficiary.

How do trusts avoid taxes?

They relinquish ownership of the property funded into it, ensuring that these assets are not included in the trust maker’s estate for estate tax purposes when he or she dies. Irrevocable trusts file their own tax reports and are not subject to estate taxes because the trust is intended to continue after the trust maker dies.

How does a beneficiary get money from a trust?

There are three main ways for a beneficiary to receive an inheritance from a trust: Outright distributionsStaggered distributionsDiscretionary distributions.

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