Trust Fund Basics Explained

This FindLaw article outlines trust fund basics and explores different types of trust funds.

Trust Fund Basics

Lawyers use trust agreements or trust documents to allow the person establishing the trust to transfer assets to a trust fund that will benefit specific individuals or organizations. The person who establishes the trust is generally referred to as one of the following:

• Settlor,

• Trustor, or

• Grantor.

Trust funds also provide tax exemptions and benefits. The IRS does not levy gift taxes on trusts.

Types of Assets

The following is a non-exhaustive list of common asset types that grantors often include in a trust:

• Bank accounts

• Retirement accounts

• Personal property

• Real property

• Life insurance and annuity proceeds

Creating A Trust Fund

Trust funds require three parties to fill each of the following roles when creating a trust fund:

Grantor

The grantor is the person who establishes the trust and transfers the money, stock, business, or other assets into the trust.

Beneficiary

The beneficiary is the person or organization intended to benefit from the trust. A beneficiary does not own the trust property. Instead, the beneficiary has the right to receive the benefit of the property as the terms of the trust allow.

Trustee

The trustee acts as a fiduciary, manages the property owned by the trust, and follows the trust's directions. A trustee can be an individual or an organization, such as a bank or a law firm. Many trusts also name a successor trustee in case the original trustee is unable or unwilling to fulfill their fiduciary duties.

What Are the Benefits of a Trust Fund?

Establishing a trust fund for your designated beneficiaries can provide substantial benefits if you plan on passing assets along to your loved ones after you die. These benefits include:

Protection of Beneficiaries

If your children are minors or lack the skills necessary to manage their own assets, a trust fund can ensure that someone else is looking after the assets on their behalf. If you are setting up a trust fund for minor children, you can set up the trust so that the assets are released to them when they reach a specified age.

Asset Protection

Putting your assets in a trust fund can ensure that other parties cannot take the assets from your beneficiaries. For example, if you set up a trust fund for one of your children and they get divorced after you die, the trust fund can be structured to ensure that the child's ex-spouse has no claim on the assets.

Reducing Estate Tax

The federal estate tax is applied to an individual's assets when they die. By placing your assets into a trust fund before you pass away, you minimize the size of your estate and can substantially reduce or eliminate the estate tax due.

Avoiding Probate

Probate is the legal process through which your assets are distributed to your beneficiaries by a probate court. While the legal process ensures that your beneficiaries receive what they deserve, probate can be time-consuming and expensive. Assets placed into a trust will usually pass to the beneficiaries outside of the probate process. A trust may reduce the need for trust administration. In contrast to a last will and testament, trusts avoid the hassle of waiting for a probate court to distribute a decedent's assets.

Types of Trust Funds

The type of trust established by the grantor will depend on both their goals in establishing the trust and the benefits they seek for their beneficiaries. Your state's laws will also govern the types of trusts available to you as well as how you create and operate trusts.

Common Types of Trust Funds

Commonly used trusts include, but are not limited to the following:

Irrevocable Trust

As the name suggests, irrevocable trusts generally can't be changed once these trusts are created. This form of trust is used by individuals concerned about estate taxes or protecting assets from future creditors.

Revocable Living Trust

Also known as an inter vivos trust, revocable living trusts are a type of trust where the grantor places assets during their lifetime. As opposed to a testamentary trust, which is created by a will after the grantor's death, a revocable living trust allows the grantor to change the trust or revoke it while they are alive. Once the grantor dies, the trust becomes irrevocable and can no longer be changed.

Special Needs Trust

Special needs trusts provide for a beneficiary who is disabled and relies on government assistance. Special needs trusts are set up to allow the beneficiary to remain eligible for Medicaid and Supplemental Security Income (SSI).

Charitable Trust

Charitable trusts distribute assets to a specified charity at the end of the trust. Benefits include immediate tax credits to the grantor and a fixed-percentage amount of income to the beneficiary during the life of the trust.

Spendthrift Trust

This trust limits the ability of a beneficiary's creditors to access the trust's assets in order to satisfy the beneficiary's debts.

Life Insurance Trust

This is an irrevocable trust whose assets include a life insurance policy.

Funding Your Trust

Funding your trust is the process of transferring your assets into your trust's name. If the property or funds do not transfer properly, the trust will still exist, but it will not fulfill its objectives. Any assets that do not correctly transfer to the trust will revert to the grantor. They will be distributed through probate under your state's intestate succession laws.

Grantors have two opportunities to fund their trust: when they are alive or after they have died. Funding your trust while you are alive ensures the process is handled according to your wishes. All titled property, such as real estate or stocks, need to have the title changed to reflect the trust's ownership.

Pour-Over Will

A "pour-over will" can be used to fund your trust after you die. The will catches any forgotten asset and sends it to your trust. However, the assets may still go through probate and be exposed to creditor claims.

Advantages of a Trust Fund

There are several advantages to creating a trust fund, including, but not limited to, the following:

• Trusts remain private, so only the trustees and the beneficiaries know your wishes. A will becomes a public record after you die.

• A trust can provide for distribution over a period of time. For example, a monthly living allowance can be provided until a child reaches a predetermined age.

• Trusts can cover property that a will cannot, such as life insurance policies and retirement plans.

• In some states, a trust can live on indefinitely.

• You can ensure your property is distributed under the conditions you set. For example, your surviving spouse can live in your family home until their death, and then the property will transfer to a named beneficiary.

• Trust funds can protect your assets from being squandered by your beneficiaries.

• Some trust assets also are excluded from your taxable estate.

Disadvantages of a Trust Fund

While trust funds offer estate planning benefits, they also have some drawbacks. For example, trust funds are usually set up by estate planning attorneys working with a financial planner who can charge hundreds of dollars an hour.

Additionally, trust funds usually incur annual management fees that pay for the work involved in overseeing the assets. The rate charged depends on the manager. Some charge a percentage of the value of the assets under management, while others charge per transaction.

One final disadvantage of a trust fund is that it is subject to federal income taxes on any income it receives from its investments and does not distribute to its beneficiaries.

Get Legal Help

If you are considering creating a trust fund, you should speak to an estate planning attorney. They are estate law experts and can guide you through creating a trust fund. They will ensure you have all of the correct legal documents to establish your trust. Speak to an estate planning attorney near you today.