Trust Fund: Meaning, Benefits, and How it Works
Learn how a trust fund works and how it can be useful for asset inheritance.
Have you always thought that trust funds are only for the ultra-wealthy? If so, you’re not alone, but trust funds can be used by people with varying economic backgrounds.
What is a Trust Fund
Trust funds are a method of estate planning that allows someone to provide for their loved ones after their death. A trust fund account makes it easy for a person to set aside funds, property, and even stocks for those they leave behind. When the grantor of the trust fund account dies, the trustee of the trust fund distributes the assets to the fund’s beneficiary.
Every trust fund needs three essential roles to be filled: grantor, beneficiary, and trustee. Let’s examine the responsibilities of each role:
- Grantor: This is the person who sets up the trust fund in an effort to distribute their assets after they die.
- Beneficiary: The grantor will name one beneficiary or multiple beneficiaries to receive the assets within the trust fund. Often, beneficiaries are children or grandchildren of the grantor, but not always.
- Trustee: Responsible for managing the trust fund, the trustee oversees the distribution of assets after the grantor’s death.
How to Set Up a Trust Fund
There are many types of trust funds and different ways to set them up. It’s recommended that a grantor works with an estate planning lawyer or a trust fund expert to get the trust fund account properly set up. Once an estate attorney has been identified, they’ll walk you through the entire process of setting up your trust fund.
General Trust Fund Creation Process:
- Collect participant details (named beneficiaries, appointed trustee, asset distribution decisions, and other details).
- Create and notarize the trust document.
- Open the trust fund account and absorb defined assets.
The Benefits of Trust Funds
Whether the grantor is setting up a child trust fund or another type, there are many benefits available to both parties involved, the grantor and the beneficiary. The grantor is able to leave this world knowing that their wealth will be preserved and distributed in the way they best saw fit. For beneficiaries, trust funds can reduce the time it takes to split the assets up and circumvent costly tax burdens when accessing the assets.
The trust fund meaning has gotten complex over time, but trust fund accounts are great for avoiding the probate process, which can be tedious and frustrating. They are also great for privacy purposes; when a person dies without a trust fund in place, the allocation of funds can be made public, making it difficult for the family to grieve and process the emotions that come with death.
Avoid Probate with Trust Funds
When someone dies, the process of splitting up their estate is called “probate.” It can be lengthy and costly, and usually only happens when someone dies without legally deciding what happens to their assets after their death. A trust fund is a legally-binding agreement that allows those funds to avoid the probate process. This makes it easier for the beneficiary to access the assets in a timely manner.
Understanding Types of Trust Funds
There are multiple approaches to setting up these strategic estate planning accounts. The grantor will work with finance experts and an attorney when selecting the type of trust fund that is right for their situation. We won’t cover every type of trust fund in this article, but a few of the more common types are:
1. Asset Protection Trust Fund
If a grantor is aiming to protect their assets from creditors that may come to collect funds, an asset protection trust fund is a great option. These types of trust fund accounts protect assets from creditors by putting them under the beneficiary’s name, removing the linkage between the assets and the grantor entirely.
2. Blind Trust Fund
With this style of trust fund, the grantor and the beneficiary are blind to how the assets are being held and managed. Instead, the trustee will make all major decisions regarding the assets, removing bias that may come from the other individuals.
3. Generation-Skipping Trust Fund
Sometimes, grantors choose to have their funds go directly to grandchildren instead of their own children; this is called a generation-skipping trust fund. There are a number of tax benefits that come with this trust fund type.
4. Spendthrift Trust Fund
A very common type of trust, spendthrift trusts do not grant the beneficiary instant and unrestricted access to the assets within their trust. Instead, beneficiaries receive smaller payments over time that are monitored by the trustee. Often, spendthrift trust funds include restrictions on how the funds can be used. These are a great option for child trust funds where young beneficiaries have the potential to make poor financial decisions.
5. Living Trust Fund
This type of trust fund is set up when the grantor is still living, and until their death, the trust fund assets benefit the grantor. When they pass away, the trustee then distributes the rest of the assets to the trust’s beneficiaries.
6. Testamentary Trust Fund
A testamentary trust fund follows the specific instructions written by the grantor who may have particular instructions when it comes to asset distribution (Ex. distribute assets once the beneficiary reaches a certain age, gets married, graduates from college, etc.). This type of trust can only go into effect after the grantor’s death.
7. Marital Trust Fund
A marital trust is typically set up by a married couple with specific terms and instructions when it comes to the passing of a spouse. This will include directions as to how to distribute assets to the surviving spouse, children, and other named beneficiaries. The martial trust is designed to help a couple’s heirs avoid probate and pay less in estate taxes.
8. Grantor Retained Annuity Trust Fund
A grantor retained annuity trust fund (GRAT) is used to reduce gift tax applied to wealth transfers between generations. In this kind of trust, the grantor locks up assets in exchange for periodic annuity payments. Once the grantor dies, the assets (and their appreciated values) can be transferred to the beneficiaries tax-free.
9. Qualified Personal Residence Trust Fund
A qualified personal residence trust (QPRT) is an irrevocable trust that allows grantors to remove their personal residence from their taxable estate. In doing so, the property can appreciate in value while the property’s “gift value” remains lower than the fair market value which helps reduce the gift tax applied to the property when transferred from the grantor to the beneficiary.
10. Charitable Remainder Trust Fund
A charitable remainder trust provides the grantor with partial tax deductions and savings. This trust setup allows the grantor to place an asset into a trust and set payments to a noncharitable beneficiary for a limited period of time. Once the payment period expires, the assets are distributed to the named charitable beneficiaries.
What is a Trust Fund Baby?
The term “trust fund baby” refers to someone who has access to money because of a trust fund that was created for them. It may have been a parent or grandparent who left them assets or someone else entirely. Usually, this term has a negative connotation and implies that the individual hasn’t had to work for his or her financial standing.
Mistakes Parents Make When Setting Up a Trust Fund
Setting up a trust fund is a legal process that requires the help of professionals. Without professional lawyers and financial advisors, there’s a lot that can go wrong. Sometimes, even with professional help, parents make mistakes when setting up a trust fund for their children. Some of the most common mistakes are:
- Choosing a trustee that doesn’t manage the trust fund with integrity or organization.
- Not including asset terms in the trust fund details. Young beneficiaries are notorious for overspending if they receive large sums of money without any guidelines.
- Failing to update the trust when life circumstances change.
Is a Trust Fund Right for My Situation?
Only you can determine if a trust fund is right for you. If you’re not sure where to start, reach out to a trusted financial advisor for more information. They can discuss all your options and help connect you with legal professionals when the time is right. The fact of the matter is: trust funds are great for wealthy individuals and non-wealthy individuals alike. If you have any assets including land, stocks, cash, or jewelry that you want distributed in a certain way, a trust fund is a great vehicle to do so.
There are many types of trust funds to choose from and multiple ways to safeguard your assets in the future. By clarifying your financial picture now and setting up a trust fund, you can help your family experience financial stability after your death.
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