Do Trust Funds Gain Interest?

When considering long-term wealth management strategies, many people wonder: do trust funds gain interest? While the answer is yes, it’s important to know how trust funds work and how they accumulate interest. Trust funds aren’t simply static accounts holding money but rather, sophisticated financial vehicles that can generate interest, dividends and capital appreciation, depending on how they’re structured and invested. Unlike basic savings accounts, trust funds can hold diverse assets, including stocks, bonds, real estate and other investments that may produce significant returns over time. The growth potential of a trust fund largely depends on its investment strategy, which is typically guided by the trust’s provisions and the trustee’s decisions.

For help with forming or managing a trust fund, consider working with a financial advisor who serves your area.

Do Trust Funds Gain Interest?

Trust funds can indeed earn interest and other investment returns.

When assets are placed in a trust, they don’t simply sit idle. The trustee, who manages the trust, typically invests these assets in accordance with the trust’s terms and investment strategy. These investments can generate interest, dividends, capital gains and other forms of income that accumulate within the trust.

Whether trust funds gain interest depends on what types of accounts and assets are held within the trust. Some accounts do gain interest, like a savings account or CD, while other investments, like real estate or collectibles, do not.

In simple terms, a trust fund is comparable to a retirement account or brokerage account. It is a way to hold items for someone’s benefit, yet the account itself doesn’t earn interest or change in value. Only the assets within the trust fund can gain interest or provide other investment returns, not the trust fund itself.

How Are Trusts Taxed?

If your trust fund earns interest, dividends, capital gains or other returns, those distributions could be considered taxable. Who pays those taxes depends on what type of trust fund you have – a revocable or an irrevocable trust.

Revocable Trusts

A revocable trust is one where the grantor, or trust creator, can amend or revoke the trust at any time. This means they have unrestricted control over the trust and can add or remove assets at any time. Only upon their death do the assets transfer to the beneficiaries. These types of trusts appeal to investors who want maximum control over their trust assets, allowing them to change the trust’s terms as needed throughout their lives.

Income from a revocable trust is treated as income for the grantor. With total control over the assets, the creator must also bear the burden of taxes due on any interest, dividends, capital gains or other payments.

In other words, income from a revocable trust is “pass-through” income, similar to the way S corporations and limited liability companies (LLCs) operate.

Irrevocable Trusts

An irrevocable trust is like a one-way street.

While the creator can control the assets within an irrevocable trust, once you transfer assets into the trust’s name, they cannot be easily removed. Because of this feature, investors often use irrevocable trusts to protect assets against lawsuits and collection efforts.

Since the creator cannot remove assets from an irrevocable trust, any gains on these assets are no longer the responsibility of the creator. All income generated by interest, capital gains, dividends and other sources is the responsibility of the irrevocable trust.

The trust fund will need to file a tax return and pay the taxes due. Each irrevocable trust has its own tax identification numbers for federal and state tax purposes.

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Do Beneficiaries Pay Taxes?

When you receive an inheritance or are named as a beneficiary, understanding your tax obligations becomes crucial.

While beneficiaries typically don’t pay inheritance taxes in most states, they may owe income tax, depending on the type of assets received and how they generate income. The tax treatment varies significantly based on whether you’ve inherited retirement accounts, life insurance proceeds or other assets.

Beneficiaries will claim the income distributions on their tax returns. However, the principal is generally not considered taxable income. The Internal Revenue Service (IRS) assumes that taxes were previously paid on assets placed into the trust.

Once you place an asset into the trust, any income received is taxable either to the trust or the beneficiaries.

How to Create a Trust Fund

A revocable trust is one where the trust creator can amend or revoke the trust at any time.

A trust fund is a legal arrangement that allows a third party, known as a trustee, to hold and manage assets on behalf of a beneficiary.

Creating a trust fund provides a structured way to transfer wealth with potential tax benefits while ensuring your wishes are carried out. Trust funds aren’t just for the ultra-wealthy; they can be valuable estate planning tools for many families who want to protect assets and provide for loved ones.

Before setting up a trust fund, clarify what you hope to accomplish.

Are you looking to provide for dependents, such as minor children or a family member with special needs?
Do you want to minimize estate taxes?
Are you concerned about protecting assets from creditors?
Do you want to ensure charitable giving continues after your lifetime?

Understanding your reasons for the trust fund will help determine which type of trust is most appropriate for your situation.

Several types of trusts exist, each designed for a different purpose.

Revocable living trusts allow you to maintain control of assets during your lifetime while avoiding probate.
Irrevocable trusts offer tax advantages but require surrendering control of assets.
Special needs trusts help beneficiaries maintain government benefits.
Charitable trusts support philanthropic goals.

Choosing the right trustee is crucial to your trust’s success. This person or institution will manage the trust assets and make distributions in accordance with your instructions.

Consider appointing someone who is financially responsible, trustworthy and willing to serve in this capacity. Some people select family members, while others prefer professional trustees, such as banks or trust companies, which offer expertise but charge trustee fees for their services.

Consulting with an estate planning attorney can help you determine how to set up your trust so it aligns with your long-term objectives.

How Trust Investment Strategies Shape Growth

A trust does not grow on its own. The trustee’s investment decisions determine whether the assets generate interest, dividends or capital appreciation.

Most trustees follow the terms of the trust document and the prudent investor rule, which requires them to manage the portfolio with reasonable care, diversification and risk control. This applies regardless of the assets the trust holds.

The investment strategy varies by trust purpose. A trust created to support a beneficiary’s current living expenses may favor income-producing assets, such as short-term bonds, dividend-paying stocks or money market instruments. Meanwhile, a trust intended to preserve or grow wealth over several decades may allocate more to long-term equities or other growth-oriented assets.

Trusts that make scheduled distributions often maintain a balanced allocation so the portfolio can generate income while preserving principal for future years. In contrast, trusts with discretionary distributions may adopt a more flexible mix, allowing the trustee to adjust the portfolio as beneficiary needs change.

The trust document may also include restrictions, such as limiting certain asset types or requiring the preservation of specific property, ultimately affecting how the trust grows over time.

Bottom Line

A man reviewing if trust funds gain interest.

It’s possible for trust funds to gain interest. However, they must hold assets that produce income. A trust fund is a type of account that holds different assets for your beneficiaries. Some assets, like a savings account, produce interest, while others do not. The party responsible for paying taxes on your trust’s income depends on the type of trust you’ve created.

Because of the complexities involved, it’s a good idea to discuss strategy with your financial advisor and tax professional to create a cohesive strategy to meet your goals.

Tips for Investing Your Trust Fund Assets

To make a plan for your trust fund assets, you may want to seek advice from a financial advisor. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Investors who place assets into a trust fund often want the money to last for many years, possibly to last over multiple generations. In order to accomplish this goal, invest the assets wisely to earn more than planned distributions. SmartAsset’s investment calculator provides forecasts of how much you’ll earn based on your starting amount, additional contributions, returns and timeframe.