Understanding Trust Funds: A Comprehensive Guide
People often associate trust funds with the ultra-wealthy, but the truth is, just about anyone can establish a trust. A trust fund is a legal entity that holds property or other assets on behalf of a person, a group of people, or an organization. Many individuals of ordinary means find trust funds helpful for estate planning or assisting loved ones in managing their finances. In this blog, we will explore how trust funds work, their benefits, and how to get started if you’re interested.
What Is a Trust Fund?
A trust fund holds property and other assets for the benefit of a person, group of people, or organization. Trust funds are commonly used in estate planning to protect assets from creditors, avoid taxes and probate, and ensure that a person’s wishes surrounding the distribution of assets are carried out as intended. For example, a trust fund might be set up to provide regular income or periodic distributions to grandchildren or to pass along assets to heirs.
How Does a Trust Fund Work?
A trust fund begins with a legal document, the trust, that spells out terms and identifies three key parties:
- The Grantor: The person who sets up the trust fund and places their assets in it. The grantor also creates the rules that govern how the fund’s assets are managed, accumulated, and distributed.
- The Trustees: Individuals or entities that manage the trust fund and carry out the trust’s directives. Trustees have a fiduciary duty to the beneficiaries of the trust, meaning they must act in the beneficiaries’ best interests within the terms set by the grantor.
- The Beneficiaries: The individuals, groups, or organizations for whom the trust is designed. The grantor designs the trust for their benefit.
What Is the Purpose of a Trust Fund?
Trust funds may be established for various purposes, including:
- Providing income for beneficiaries, such as a special needs child
- Distributing assets after the grantor’s death
- Providing support and paying expenses if the grantor is incapacitated
- Contributing to charity
Trust funds may hold different types of assets, including investment accounts, businesses, real property, or bank accounts. The grantor decides when and how beneficiaries receive assets, such as paying a set amount annually or providing a lump-sum payment when they reach a certain age. The grantor may also specify how the funds can be used, such as for college expenses or a home down payment.
How to Set Up a Trust Fund
To set up a trust fund, you’ll need to make some key decisions about the type of trust, trustees, and beneficiaries you want, then prepare trust documents and fund the trust. Working with an estate planning or trust attorney can be invaluable here. Although it’s possible to set up a simple living trust with the help of a guidebook or dedicated software, an attorney can help you decide which type of trust works best for you, create trust documents that fit your needs, and walk you through the process of moving assets into it.
To get started, answer these questions:
- What is the purpose of your trust?
- Who are your beneficiaries?
- Who will be the trustee?
Use your answers to prepare trust documents, which typically need to be signed and notarized. Once your trust documents are completed, you’ll move ownership of your key assets to the trust. Because this process can be complicated, working with an attorney can be key. A qualified attorney can answer your questions, make sure your trust meets legal requirements, and guide you through the transfer of assets.
Types of Trust Funds
There are many types of trusts, each designed to meet a different set of needs. Here are some commonly used types of trusts:
- Revocable Trust: Allows the grantor to continue to control the assets during their lifetime. The grantor can make changes to or revoke the trust at will.
- Irrevocable Trust: Once assets are placed in an irrevocable trust, the grantor no longer has control over them, and it can be difficult to make changes or revoke the trust.
- Blind Trust: Neither the grantor nor the beneficiary sees what assets are held in the trust. Often created to help public figures avoid conflicts of interest.
- Charitable Remainder Trust: An irrevocable trust that pays income to a beneficiary for a limited term or for life, then donates the remaining assets to designated charities.
- Special Needs Trust: Provides for an individual with special needs without disqualifying them from receiving government disability benefits.
- Generation-Skipping Trust: Assets pass directly to the grantor’s grandchildren, bypassing estate taxes that might apply if assets passed to the grantor’s children.
Revocable vs. Irrevocable Trust Funds
Choosing between revocable and irrevocable trust funds can be confusing. Both types allow you to pass assets to your heirs privately without going through the probate process, but they differ in their structures and the benefits they provide. Here’s a quick comparison:
Revocable Living Trusts
A revocable living trust is easier to modify than an irrevocable trust. With a revocable trust, the grantor can amend the terms of the trust at any time and manage the trust fund as its trustee. A revocable living trust may offer more flexibility by allowing the grantor to:
- Name a different (or additional) trustee
- Change beneficiaries
- Pull assets out of the trust
Irrevocable Trusts
Irrevocable trusts aren’t as easily amended as revocable trusts. In an irrevocable trust, the grantor relinquishes ownership of any assets they place in the trust. Because the assets in an irrevocable trust no longer belong to the grantor, they may have additional protections:
- Assets in an irrevocable trust may be protected from creditors.
- Trust fund assets may pass to heirs without being counted toward the federal estate tax exclusion.
- Holding assets in an irrevocable trust may help you qualify for certain wealth-qualified government benefits, such as Medicaid.
Which is better, a revocable trust or irrevocable trust? An estate or trust attorney can help you decide based on your individual needs and concerns.
5 Benefits of Trust Funds
There are many reasons to set up a trust fund, and you don’t have to pick just one. Among the many benefits of establishing a trust, here are five to consider:
1. Avoiding Probate
When you die, your will goes through a probate process in court and becomes a public document for anyone to view. Court costs can add up, and a typical probate may take months to complete. A trust allows your plans to remain private and helps you avoid probate altogether.
2. Minimizing Taxes
In addition to federal estate taxes, state or local jurisdictions may also impose some form of inheritance or estate tax. An irrevocable trust can protect certain assets from these taxes. Note, however, that income and capital gains from a trust fund may be taxable. Grantors may want to consult with a tax advisor for more information.
3. Controlling the Distribution of Assets
As grantor of a trust, you can stipulate exactly how the assets in the trust should be managed, accumulated, and distributed.
4. Protecting Assets From Creditors
In some cases, transferring ownership of your assets into an irrevocable trust may help to protect them from creditors. This may be helpful to preserve the amount you’re able to pass down to your heirs if, for example, you leave debt after you die or if you declare bankruptcy after you’ve created the trust.
5. Helping a Family Member Manage Finances
A trust can provide a framework for offering needed financial help and guidance for a family member or friend. Setting up a trust for the benefit of a child or grandchild, or stepping in as a successor trustee when an aging loved one becomes incapacitated, are two meaningful ways trusts can help.
The Bottom Line
Not everyone needs a trust fund. But if you’re concerned about distributing assets to your loved ones—while you’re alive or after you’ve passed—a trust fund may help ease the process, minimize taxes and other expenses, and provide some protection against creditors. If you want to learn more but aren’t sure where to start, consider finding a local estate planner or trust attorney to answer your questions and suggest a trust that will suit your individual needs.
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