Do Trust Funds Gain Interest?

A trust fund is a legal entity designed for holding assets, not a specific type of account as is thought in the popular imagination. Because of this, trust funds can be the owner of a variety of different assets, including cash, investments, real estate and collectibles. So, do trust funds gain interest? It depends. Here’s what you need to know about whether trust funds gain interest on their assets. For help with forming or managing a trust fund, consider finding a financial advisor.

The answer of whether or not 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 others, 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 the benefit of someone, yet the account itself doesn’t earn interest or change 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 – revocable or irrevocable trust.

Revocable Trusts

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

Income from a revocable trust is treated as income for the creator. 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 or limited liability companies (LLC) 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 against the creator.

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 must file its own taxes and pay the taxes due. Each irrevocable trust has its own tax identification numbers for federal and state tax purposes.

Do Beneficiaries Pay Taxes?

Beneficiaries do not owe taxes on any income earned on assets held within the trust. However, once distributions to the beneficiaries begin, they may owe taxes on some or all of the money received. In most cases, the trust fund distributions will be a portion of income and principal, similar to distributions from an annuity.

Beneficiaries will claim the income distributions on their tax returns. However, any amount that is 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 beneficiaries.

The Bottom Line

If you are wondering do trust funds gain interest, the answer is “yes, it is possible.” However, they must hold assets that produce income. A trust fund is a type of account that holds a variety of assets for your beneficiaries. Some assets, like a savings account, produce interest, while others do not. Who pays taxes on your trust’s income depends on the type of trust you’ve created. Because of the complexities of this topic, we recommend discussing strategy with your financial advisor and tax professional to create a cohesive plan to meet your goals.

Tips for Investing Your Trust Fund Assets

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. Our investment calculator provides forecasts of how much you’ll earn based on your starting amount, additional contributions, returns and timeframe.
To make a plan for your trust fund assets, it is wise to seek advice from a financial advisor. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.