A trust can be funded with a variety of different asset types. Investments such as stocks, bonds, mutual funds and exchange-traded funds (ETFs) can easily be used to fund a trust by titling a brokerage account accordingly. Additionally, real estate and other collectible assets can be held within a trust but must be carefully titled to avoid probate issues. ETFs are excellent investments to use within a trust due to the diversification and tax efficiency they can provide.

A trust is created as a legal entity that lets its creator put conditions on how certain assets are distributed upon his death. Essentially, setting up a trust enables the grantor to have control from the grave. The grantor creates the trust and stipulates who is in control and how assets are to be distributed. Unlike a will, a trust does not have to go through probate and is a useful tool for estate planning purposes. There are two types of trusts: revocable and irrevocable. A revocable trust allows the grantor to change stipulations of the trust during his lifetime. However, a revocable trust does not receive the same estate and creditor treatment as an irrevocable trust. An irrevocable trust is first established by the grantor, who then relinquishes control. This allows the assets within the irrevocable trust to be held outside of the grantor’s personal assets and taxed as their own entity.

Why Use ETFs in a Trust?

When it comes to choosing the appropriate investments within a trust, the end purpose of the trust must first be understood. Whoever is in control of the trust, known as the trustee, has a fiduciary responsibility to make financially sound decisions that are in the best interest of the trust. ETFs are excellent investment tools to help assist any trustee achieve the trust’s goals. ETFs are diversified baskets of investments designed to mirror an index or benchmark. An ETF is also one of the lowest-cost investment solutions available and is significantly less expensive than mutual funds or annuities.

Another added benefit that ETFs have over mutual funds is the taxation. Trusts can be taxed at a bracket that is much higher than an individual’s tax bracket. Mutual funds often issue capital gain distributions to their shareowners. When held in a trust, it triggers higher, unnecessary taxes that could potentially erode principal. ETFs do not issue capital gain distributions and are only taxed when dividends are issued or are bought and sold as capital gains or losses.

Income-Paying Trusts

Most trusts are designed to preserve the principal for future generations while providing no income to the trust’s beneficiaries. A trust that is designed for this purpose can be designed using ETFs. Vanguard offers an Intermediate-Term Corporate Bond ETF (NYSEARCA: VCIT) that can maintain principle through the fixed-income market. The fund invests in primarily investment-grade corporate bonds and, as of July 8, 2016, had a yield of 2.87%. The fund is also very inexpensive, with an expense ratio of 0.1%.

Investors looking for exposure to the stock market with a desire to receive a dividend have many options within the ETF world. Global X Funds has created an ETF called the SuperDividend ETF (NYSEARCA: SDIV). As of June 30, 2016, the fund had a yield of 7.67% and invested in the top 100 highest dividend-paying stocks in the world, for an expense ratio of 0.58%. This is a good portfolio for capital appreciation tied with the stock market but looking to maximize current income needs.

Growth Trusts

Some trusts are not designed to pay income to the beneficiaries, but instead are more geared for capital appreciation, allowing funds to be passed on to future generations. The State Street SPDR S&P 500 ETF (NYSEARCA: SPY) is the most popular ETF in the world and is designed to mirror the S&P 500 index. As of June 30, 2016, the fund had produced an average 10-year return of 7.32% for its investors.

Investors looking for a growth opportunity could look to the iShares NASDAQ Biotechnology ETF (NYSEARCA: IBB). The fund invests in 188 U.S.-based biotechnology and pharmaceutical companies for an expense ratio of 0.48%. As of June 30, 2016, the fund produced a 10-year average return of 13.68% for its investors.

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