The term “trust fund baby” is associated with a negative stigma. It brings up images of privileged children who grew up having every material possession that money could buy. While that may be true in some instances, it is far from the norm when talking about trust funds.

Most people would be surprised at how many trust funds have been established for children. It has nothing to do with providing an excessive amount of cash so that the young person can buy whatever they want. Instead, a trust fund is established so that if the parents are not around to provide for the child, the child has a source of income and assets necessary to survive. (See also: How To Set Up A Trust Fund If You're Not Rich.)

If you have life insurance, this probably sounds familiar. In fact, if you have life insurance, and your underage children are beneficiaries, they will have a trust fund established for them if you happen to pass away.

Unfortunately, there are a number of mistakes that parents make when creating trust funds for their children. Many are the result of not knowing how these funds are supposed to work.

If you have a great attorney working for you, many of these problems never arise. However, there are many times when things slip through the cracks, or the individual setting up the trust simply doesn’t have the necessary experience. Here are some of the most common mistakes that parents make when they set up a trust for their children.

Key Takeaways

  • When establishing a trust fund for your children, be sure to pick the right trustee, keeping in mind that a family member may not always be the right person.
  • Be aware that young adults aren't great at managing money, and put in place limits to what they can withdraw the money for, particularly when they are under the age of 25.
  • Make sure you have your paperwork in order and that the correct beneficiaries are named, including the name of the trust when appropriate.
  • Be sure to review the trust each year to make sure you still feel comfortable with the trustee and with other aspects of the plan.
  • Don't forget about college planning and how the money in the trust might impact any request your children make for student loans or scholarships.

Choosing the Wrong Trustee

Choosing a trustee doesn’t sound too hard to do. You think that since your children have a great relationship with your brother or sister (their aunt or uncle), that they will be great trustees. Even if this family member agrees to take on that role, it may not be in his or her best interest to have financial control over your children’s assets. This especially holds true if the trust is set to turn over full control to the child at age 25, and the trustee has to be the bad guy and not let your children have access at age 23.

A better alternative to a family member is to let the bank act as trustee. To keep that personal touch, let the bank and a sibling act as co-trustees. (See also: What are typical trust fund management fees?)

Establishing a trust fund for your minor children enables them to have access to the funds that they may need in case you pass away.

Setting the Wrong Goals

Most young adults are not responsible with money. Even though your children become adults at age 18, it is likely not in their best interest to gain full control over the money at that age.

When setting up the trust, you get to decide what the money can be used for before the age of maturity. Hospital bills, education, and weddings are common reasons to withdraw money. Anything else and you can set the trust up so that the money can’t be retrieved until a certain age is reached.

Designating the Wrong Beneficiary

When you purchase your life insurance, you get to decide who the beneficiary is. After you have established your trust, did you change the beneficiary from the name of your children to the name of the trust?

Unless specifically designated, your estate will receive the assets, not the trust fund you set up for your children.

Not Reviewing the Trust Annually

When you set up the trust fund, you may have chosen a responsible family member to act as a trustee. After 10 years, you have forgotten about that designation, but you have watched that family member slip into depression, maybe get involved with drugs or alcohol, and accumulate a criminal record. Is that who you still want to be in charge of your children’s finances?

Just like your life insurance, investments, and overall financial planning, you will want to review the trust every year to make sure it is still true to your desires and current overall realities.

Forgetting About College Planning

The most common trust funds for children are UGMA​ or UTMA​ accounts. They are generally very simple administratively, and you just have to add money to them regularly in order to make sure that they are fully funded. But did you know that these accounts must be listed as assets owned by the minor when they apply for college financial aid? If there is any substance to them, they may end up disqualifying your child from receiving grants, scholarships, or sometimes even loans.

The Bottom Line

You have worked hard for your money. Many people want to make sure their family is taken care of. Since they can’t outright give the money to their minor children, they establish a trust fund on their behalf. When done correctly, these trust funds can help children through rough patches, pay medical bills, fund college expenses, put down payments on houses, establish businesses, and much more.

When a trust is established incorrectly, funds can end up wasted. Would you rather see your children benefiting from the assets, or would you rather the state probate court get rich off your back?