What Is a Trust Fund? A Comprehensive Guide

A trust fund is a powerful tool that has stood the test of time. It is an essential instrument in modern wealth management and estate planning that safeguards individuals’ wealth and legacy.

This guide explains what a trust fund is, how it works, various types available, and some advantages and disadvantages.

What Is a Trust Fund?

Trust funds are legal arrangements that enable individuals to put assets in the hands of a third party (the “trustee”) to benefit another person or organization. Establishing a trust fund can be complex and may require the help of an attorney. Trusts can be of various types, including testamentary (established through a will), living, revocable, or irrevocable.

How Do Trust Funds Work?

Trust funds provide individuals with financial, tax, and legal benefits. A trust fund can determine how an individual’s assets or other financial matters (life insurance, investments, creative work, personal property, real estate, and debt) will be managed and distributed after their death. A trust requires three main parties:

• A grantor, who establishes and funds the trust,
• One or more beneficiaries, who receive benefits from the trust, and
• A trustee, who manages the estate and distributes the assets as per the grantor’s wishes, either through a regular income stream or a lump sum payment.

Revocable and Irrevocable Trusts

Typically, there are two broad categories of trust funds: revocable and irrevocable.

Revocable Trust Funds

A revocable trust fund, also known as a living trust fund, allows the grantor to have greater control over their assets during their lifetime. Assets placed into the trust can be transferred to any chosen beneficiaries upon the grantor’s death. This trust allows for the transfer of assets to their children or grandchildren.

The main advantage of a revocable trust is that it avoids probate, which ensures a quick and private distribution of assets to beneficiaries. Living trust funds maintain high privacy as they are not publicly disclosed.

A revocable trust can be changed or completely revoked prior to the grantor’s death.

Irrevocable Trust Funds

An irrevocable trust fund is challenging to modify or revoke after it’s created. It allows the grantor to transfer control of assets to the trust fund and receive tax benefits. Typically, assets in an irrevocable trust also avoid probate.

Types of Trust Funds

Various types of trust funds can be incorporated into your estate plan:

• Charitable trusts—A charitable trust fund can support a specific charity or benefit the general public. There are two main types of charitable trusts: the Charitable Remainder Annuity Trust (CRAT) and the Charitable Remainder Unitrust.
  • A CRAT provides a fixed annual payment to the chosen charity or public benefit organization.
  • A Charitable Remainder Unitrust disburses assets to the chosen beneficiary when the fund ends. Furthermore, the donor receives a charitable deduction and the charity receives a fixed proportion of income during the life of the trust.
• Asset protection trusts—An asset protection trust safeguards an individual’s assets from potential future claims of creditors.
• Special needs trusts—Special needs trusts benefit individuals (beneficiaries) with disabilities without jeopardizing their eligibility for government benefits.
• Spendthrift trusts— A spendthrift trust restricts beneficiaries from immediately accessing the assets, prohibiting them from selling, spending, or giving them away without fulfilling specific conditions.
• Blind trusts—This type of trust is intended to prevent any potential conflicts of interest. The person who created the fund and the beneficiary are unaware of the assets or their management. Instead, the trustee has complete control over the fund.
• Qualified personal residence trusts—An individual can transfer their primary residence from their estate to a qualified personal residence trust to decrease gift tax liability.
• Qualified terminable interest property—A Q-TIP trust benefits the surviving spouse while allowing the grantor to make decisions after the surviving spouse’s death.
• Generation-skipping trusts—Generation-skipping trusts offer tax benefits for beneficiaries who are the grantor’s grandchildren or at least 37½ years younger than the grantor.
• Medicaid trusts—Medicaid trusts allow a grantor to get rid of assets being left to their dependents. The grantor can then qualify for Medicaid long-term care benefits.
• Testamentary trusts—Testamentary trusts are included in a person’s last will and testament and come into existence upon their death. Testamentary trusts allocate assets to beneficiaries with instructions to be followed after the grantor’s death.

Benefits of a Trust Fund

• Asset management—Revocable trusts can be a valuable means for managing and controlling wealth, especially for older individuals whose children reside in distant locations. When assets are placed into a trust, they are registered under the trust’s name, facilitating the consolidation of various assets under a single umbrella. After the grantor’s death, a trustee retains control of managing the assets
• Avoiding probate— Typically, a trust bypasses the probate process (which can be both time-consuming and expensive) and transfers assets directly to the beneficiaries, or to a trustee to manage on behalf of the beneficiaries.
• Privacy—A revocable trust lets you remove your property ownership details from public records. To maintain confidentiality, consider trust names that disguise personal information, such as the LLT Revocable Trust instead of the Lana Linet Taylor Revocable Trust.
• Tax management— The federal estate tax is levied on an individual’s assets upon their death. Transferring assets to a trust fund before death can limit the size of your estate and reduce or eliminate the estate tax liability.
• Responsible transfer of wealth—An irrevocable trust can be a valuable tool for teaching children about appropriate wealth management. For example, an irrevocable trust can specify that beneficiaries must meet particular conditions, such as attending college or having a job, before they can receive benefits.
• Asset protection—Putting assets in a trust fund can help you secure them for your chosen beneficiaries. For instance, if you create a trust fund for one of your children and they face a divorce after your death, the trust can be structured to prevent the child’s ex-spouse from claiming the assets.

Drawbacks of a Trust Fund

• High costs—The cost of creating a revocable trust can vary depending on factors such as the estate’s complexity, state of residence, legal fees, asset retitling, tax filing, and trustee fees.
• Extra complexity—Many individuals create a revocable trust to avoid probate after their death. If they fail to keep track of any new asset acquisitions, and transfer them into the trust, their heirs might still encounter probate proceedings.
• Not a substitute for an estate plan—A trust fund is not a substitute for an estate plan. Instead, it is one component of a comprehensive estate plan that may also impact your tax strategy.
• Faith in your trustees—Appointing a trustee is a crucial decision, similar to appointing an executor in your will. It requires a high level of trust in the individual you choose to manage and distribute the assets in the trust.
• Permanence—Irrevocable trusts have a significant drawback as they are permanent. The law of some states may allow for minor modifications post-creation, but that’s not a generally available option. The permanent nature of irrevocable trusts often deters grantors from using them, despite their benefits.

Hire a Professional To Set up Your Trust Fund

Trust funds can be complex legal entities with intricate rules. Various types of trusts are employed to address specific situations. Determining whether a trust fund suits you depends on your circumstances, objectives, and state regulations.

If you are considering establishing a trust fund as part of your estate plan, it is recommended that you seek the advice of a professional who has experience in trust fund management. They can:

• Provide personalized guidance based on your unique situation and objectives
• Ensure that your trust is properly drafted and complies with legal requirements
• Help you implement tactics to protect assets from creditors
• Help you structure your trust in a tax-efficient manner