Trust Fund

What Is a Trust Fund?

The term trust fund refers to an estate planning tool that establishes a legal entity to hold property or assets for a person or organization. Trust funds can hold a variety of assets, such as money, real property, stocks and bonds, a business, or a combination of many different types of properties or assets. Three parties are required in order to establish a trust fund: the grantor, the beneficiary, and the trustee. Trusts can take many forms and can be established under different stipulations. They offer certain tax benefits as well as financial protections and support for those involved.

Key Takeaways

  • A trust fund is designed to hold and manage assets on someone else's behalf, with the help of a neutral third party.
  • Trust funds include a grantor, beneficiary, and trustee.
  • The grantor of a trust fund can set terms for the way assets are to be held, gathered, or distributed.
  • The trustee manages the fund's assets and executes its directives, while the beneficiary receives the assets or other benefits from the fund.
  • Trust funds can be revocable and irrevocable trusts and there are several variations that exist for specific purposes.

Trust Fund

How Trust Funds Work

Estate planning is a process that involves determining how an individual's assets and other financial affairs will be managed once they become incapacitated and how any property they have is distributed after they die. This includes any bank accounts, investments, personal property, real estate, life insurance, artwork, and debt. While wills are the most common estate planning tools, trust funds are also popular legal entities.

The following three parties are involved in establishing a trust fund:

  • The grantor, who sets up the trust and populates it with their assets
  • The beneficiary(s) or the person (people) chosen to receive the trust fund assets
  • The trustee, who is a neutral third party (an individual or a trust bank) charged with managing the assets in the trust

The grantor generally creates an arrangement that, for a variety of reasons, is carried out after they are no longer mentally competent or alive. As the appointed fiduciary, the trustee is responsible for carrying out the interests of the grantor. This usually includes allocating living expenses or even educational expenses, such as private school or college expenses, while they are alive. Or they can pay out a lump sum directly to the beneficiary.

Trust funds provide certain benefits and protections for those who create them and to their beneficiaries. For instance:

  • They keep assets held away from any creditors in the event they decide to pursue the grantor for unpaid debts.
  • They avoid the need to go through probate, which is the process of analyzing and distributing assets after someone dies without leaving any instructions behind.
  • They reduce the amount of estate and inheritance taxes owed after the grantor dies and assets are distributed to the beneficiary(s).

An estate tax is levied on the value of an estate after the grantor dies while inheritance taxes are applied to the total amount a beneficiary inherits from an estate.

Special Considerations

Wealth and family arrangements can grow quite complicated when millions (or even billions) of dollars are at stake for multiple generations of a family or entity. As such, a trust fund can contain a surprisingly complex array of options and specifications to suit the needs of a grantor. 

But contrary to what most people believe, trust funds aren't just for the ultra-rich. In fact, they can be useful for just about anyone, regardless of their financial situation. Discuss your needs with a financial professional to find out what kind of trust is well-suited for you and your personal needs.

Revocable Trust Funds vs. Irrevocable Trust Funds

Revocable Trust Fund

A revocable trust lets a grantor better control assets during the grantor’s lifetime. Once assets are placed into the trust, they can then be transferred to any number of designated beneficiaries after the grantor's death. Also called living trust, a revocable trust can be used to transfer assets to children or grandchildren.

The primary benefit of this kind of trust is that the assets avoid probate, which leads to the quick distribution of assets to the listed beneficiaries. Living trusts are not made public, meaning an estate is distributed with a high level of privacy. 

Changes can be made to the trust while the grantor is alive. The trust can also be revoked in its entirety prior to the grantor's death.

Irrevocable Trust Fund

An irrevocable trust is very difficult to change or revoke. Because of this arrangement, there can be considerable tax benefits for the grantor to effectively give away control of the assets to the trust fund. Irrevocable trusts most often avoid probate.

People often use the terms trust fund and trust interchangeably. While they are very similar, there are a few differences between them. A trust fund is a legal entity but a trust is a legal agreement that outlines how assets are to be treated, managed, and distributed.

Types of Trust Funds

In addition to the common revocable and irrevocable trust arrangements, there are other types of trust funds. A tax or a trust attorney may be your best resource for understanding the intricacies of each of these trust funds.

  • Asset Protection Trust (APT): This trust protects a person's assets from their creditors' future claims.
  • Blind Trust: In a blind trust, the beneficiary is not aware of who holds power of attorney (POA) for the trust. This is generally the trustee.
  • Charitable Trust: A charitable trust benefits 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 (CRUT) passes assets to a specified charity once the trust expires, and gives the donor a charitable deduction as well as a fixed percentage of income to the beneficiary during the trust's life.
  • Generation-Skipping Trust (GST): This kind of trust contains tax benefits when the beneficiary is one of the grantor’s grandchildren, or anyone at least 37½ years younger than the grantor.
  • Grantor Retained Annuity Trust (GRAT): Establishing a GRAT helps to avoid gift taxes.
  • Individual Retirement Account (IRA) Trust: An IRA trust can minimize taxes on qualified assets within the trust.
  • Land Trust: A land trust allows the trust to manage property held in the trust.
  • Marital Trust: This trust is funded at one spouse's death and is eligible for the unlimited marital deduction.
  • Medicaid Trust: Elderly individuals avoid tax and probate issues for assets related to Medicaid matters and payments.
  • Qualified Personal Residence Trust: A qualified personal residence trust moves a grantor’s residence out of the estate.
  • Qualified Terminable Interest Property Trust: A qualified terminable interest property trust benefits a surviving spouse but allows the grantor to make decisions after the surviving spouse’s passing. 
  • Special Needs Trust: A special needs trust is created for a person who receives government benefits so as not to disqualify the beneficiary from such government benefits.
  • Spendthrift Trust: A spendthrift trust beneficiary cannot sell, spend, or give away trust assets without specific stipulations.
  • Testamentary Trust: A testamentary trust leaves assets to a beneficiary with specific instructions following the grantor’s passing. 

What Is a Trust Fund Baby?

A trust fund baby is someone whose parents set up a trust fund in their name. The term is often used negatively. When people use the expression, there's an implication that beneficiaries are born with silver spoons in their mouths, are overly privileged, and don't have to work to live.

It's true that trust funds can provide beneficiaries with security. But in reality, many so-called trust fund babies don't live luxuriously or in high society.

How Do Trust Funds Work?

Trust funds are legal entities that provide financial, tax, and legal protections for individuals. They require a grantor, who sets up the trust, one or more beneficiaries, who receive the assets when the grantor dies, and the trustee, who manages the trust and distributes the assets at a later date.

Trust funds are designed to carry out the wishes of the grantor. This means that the trustee is in charge of managing the assets while they are still alive. After their passing, the trustee can pass on the assets to the beneficiary(s) as per the grantor's instructions, whether that's through a regular income stream or a lump sum payment.

How Do I Start a Trust Fund?

In order to set up a trust fund, you'll need to figure out which one is best suited for you, so make sure you figure out the exact purpose of the fund. Then, decide how you'll fund the trust. Figure out who you want to appoint as your trustee. This person may be able to help you draft up all the documents and go through the legal process. The final step is to fund the trust fund.

As with any other financial venture, make sure a trust fund is the best choice for you, your beneficiary, and your financial situation.

Article Sources

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  1. Internal Revenue Service. "Instructions for Form 5227: Split-Interest Trust Information Return," Pages 1-2.

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