Trust Fund: What Is It, And How Does It Work?

There’s more to a trust fund than meets the eye. Many think of trust funds as tools for wealthy individuals, but they can be valuable protection for anyone’s beneficiaries. If you want to protect vulnerable family members or young children after you’re gone, a trust fund might be the right choice.

What Is A Trust Fund?

A trust fund is a legal arrangement or estate planning tool that allows individuals to set money, property and other assets aside in a trust to be distributed to their heirs or beneficiaries. Trust funds can provide your loved ones with financial support after you’ve passed away and can protect them from the stress of having your assets reviewed in probate court.

Three parties are involved in setting up a trust fund:

• Grantor: The grantor is the person who opens the trust fund and puts their assets in it.
• Beneficiary: The beneficiaries or heirs are the people the grantor’s assets will be distributed to.
• Trustee: The trustee is the person or party who manages the assets in the trust fund. 

Although many associate the elite with trust funds, people of all socioeconomic backgrounds can benefit from establishing a trust fund.

Revocable Vs. Irrevocable Trusts

When you decide to set up a trust fund, it will either be revocable or irrevocable. The crucial difference between a revocable and irrevocable trust is whether the grantor can exert any control over the trust once it’s established.

What’s A Revocable Trust?

With a revocable trust – also referred to as a living trust – the grantor can change, update or cancel it. Outside of estate tax avoidance, grantors can still use the assets to achieve their goals without giving up control over the property. In fact, if this is possible, most prefer to retain authority over their trust.

What’s An Irrevocable Trust?

An irrevocable trust cannot be changed or altered by the grantor after it’s established and funded. It also cannot be revoked after their death. Typically, an individual considers establishing an irrevocable trust as part of their estate plan or to transfer large amounts of wealth.

You may also be able to obtain tax benefits from establishing an irrevocable trust. Typically, the IRS will only give estate tax benefits to grantors who lose control of their property after making the trust. Plus, because you’ve relinquished possession of your assets, you won’t have to pay income taxes on the interest you’d typically make from the assets, either.

How Does A Trust Fund Work?

Once the grantor sets up the trust fund, they can transfer their assets to it. The trust fund can then shelter those assets until they’re passed onto the designated beneficiaries.

Assets include various items, bank accounts and properties. Grantors can transfer cash, liquid assets like stocks and fund balances, and personal property, like jewelry, into the trust. If a grantor wants to include real estate with the assets, they’ll have to change the title to reflect the trust’s ownership of the property.

The grantor can do whatever they want with any assets transferred to a revocable trust. They can even continue to use or change assets up until their death or incapacitation. However, once the trust is out of the grantor’s control, like with an irrevocable trust, the established document dictating what is to be done with the assets must be followed.

What Are The Different Types Of Trust Funds?

The type of trust fund you set up depends on the purpose you want your trust to serve. They are customizable, so your estate planning attorney can help you establish the most appropriate trust for your needs. It’s more important that you first determine what purpose you want your trust to serve.

Once you have an idea in mind, speak to your attorney. You should run any specific questions you have by them. That way, you ensure your planned trust fits in perfectly with your unique circumstances. With that in mind, here is a sample of different types of trust funds.

Testamentary Trust

A testamentary trust is established according to the directions outlined in a last will and testament. This type of trust is different from a revocable or living trust in that the trust is created after the grantor’s death.

In the will, the grantor provides instructions to the executor (or the person who manages the will) explaining how their assets will be distributed by the trustee (or the person who manages the trust). The trustee is then responsible for handling the testamentary trust and distributing the assets to the beneficiaries accordingly.

It’s important to note that a grantor may include instructions to establish more than one testamentary trust following their death.  

Special Needs Trust

If you’re a parent of a child who has disabilities, you want to make sure they’re taken care of after you pass. A special needs trust provides financial support for a disabled child, whether young or an adult, in a way that won’t disqualify the child from receiving government benefits. Keep in mind that the trust has to be structured so that its proceeds aren’t used in any way that violates rules for Social Security insurance and Medicaid benefits.

As long as the funds aren’t direct cash payments to the disabled individual or used for food and shelter, they can cover supplementary needs. This can include things like transportation or home care.

Spendthrift Trust

Some parents may be concerned about their children’s spending habits. They worry the child will misuse their finances, particularly if it’s a large lump sum of money.

For example, if the child exhibited substance abuse issues in the past, the parent of said person might prefer to leave their estate in a trust that limits funds. It only provides enough to cover basic expenses.

Another instance might be where the parent creates a trust that allows the child to have an income up to a certain age. The hope is that they’re mature enough at that point and can then have access to the trust’s assets.

Generation-Skipping Trust

This trust bypasses the grantor’s child and instead passes them on to the grantor’s grandchild. One reason to choose a generation-skipping trust is for tax planning purposes. Others may use this trust to cut their child out of their inheritance while still providing for their grandchildren. The assets can support the grandchildren if the parents are negligent, or they can cover large future expenses, like college.

Charitable Trust

You may want to provide income for your child long-term but also to support your favorite organization. A charitable trust breaks up into a charitable lead trust and charitable remainder annuity trust. The former donates a set amount to a charity, leaving the rest to the beneficiaries, whereas the latter uses the opposite route.

Benefits Of A Trust Fund

Establishing a trust fund can provide a number of benefits to grantors and their beneficiaries. Let’s walk through some of the advantages associated with opening a trust fund.

• More control over the distribution of your assets: Trust funds allow grantors to determine how their assets are managed and distributed. This can provide grantors the peace of mind that their beneficiaries will be taken care of when they pass on.
• Protection from creditors: If the grantor has unpaid debts, some types of trust funds protect their assets from creditors. That way, the designated beneficiaries will still receive their inheritances.
• Avoid probate court: If a grantor establishes a revocable trust, their beneficiaries will avoid probate court when the time comes to distribute the grantor’s assets. This also keeps the grantor’s and their loved one’s financial matters private after death.   
• Potential tax benefits: The grantor’s assets in an irrevocable trust cannot be taxed after the grantor passes away. 

How To Set Up A Trust Fund

Once you know the type of trust you need, you’ll want to set it up. But, trust laws depend on the state the grantor lives in and the property’s location. So, the process will vary.

1. Meet With An Attorney Who Specializes In Trusts

To get started with creating your trust fund, find an attorney who specializes in estate planning or elder/senior law. Know that meeting with an estate planning attorney can come with a hefty price tag. Setting up a trust can be expensive, and the bulk of the expenses include legal fees and administrative costs. These fees will vary by state.

2. Appoint A Trustee

The trustee manages any assets placed into the trust. Unlike an executor, the trustee’s job lasts until the funds are distributed. The trust may also lay out additional responsibilities. If the grantor is healthy, they can act as a trustee, typically to a revocable trust.

However, the grantor should appoint a co-trustee in case they, the grantor, pass away or become incapacitated.

3. Choose Your Beneficiaries

After appointing your trustee, you’ll want to determine the beneficiaries who will inherit your assets when you pass on. Your beneficiaries may include your spouse, children, family members or friends. Depending on the type of trust fund you choose, you may also want to name charities or other organizations as your beneficiaries.

4. Transfer Your Assets To The Trust

Once the trust is established, the grantor can simply transfer their assets to the trust. But, in the case of real estate, the grantor has to change the title of the property per the ownership change. 

Trust Fund FAQs

Are you still curious about how trust funds work? Let’s explore some frequently asked questions about trust funds.

What is the purpose of a trust fund?

The purpose of a trust fund is to hold your money, property and other assets in a special account to be distributed to your beneficiaries at a later time. A trust fund is meant to give the grantor the peace of mind that their assets and beneficiaries are taken care of after death. 

What is the difference between a trust fund and an inheritance?

A trust fund is a legal entity that allows you to place your assets in an account for your beneficiaries to receive when you pass on. An inheritance, on the other hand, refers to the money or assets that are passed onto loved ones when an individual dies.  

What assets can I transfer to a trust fund?

• The assets you may want to place in a trust fund for your beneficiaries include (but aren’t limited to) the following:
• Bank accounts, like checking accounts, savings accounts, money market accounts and certificates of deposit (CDs)
• Real property, including your house, land and any real estate investments
• Stocks, bonds, annuities and other types of investments
• Life insurance policies

Do I need a trust fund?

Whether you need a trust fund depends on a few factors, including the sum of your assets and if you have loved ones or charitable organizations you want to pass your assets onto. The legal process that comes along with creating a trust fund may give you a greater sense of security than if you proceed without one.

Having a trust fund also gives you more control over the distribution of your money and assets before you pass on. 

The Bottom Line: Trust Funds Give Grantors Peace Of Mind

Trust funds are a valuable resource that allows you to keep assets safe for your beneficiaries. Most of all, grantors can ensure their loved ones are cared for when they’re not there.

When it comes to estate planning, it’s important to keep all your finances in order. With the Rocket Money℠ app, you can monitor your assets, debts and overall net worth right on your mobile device. That way, you’ll feel prepared when it comes time to decide how to distribute your assets.

Take financial planning to the next level, and download Rocket Money today.