When people hear that a child has a trust fund, they often assume that the child is incredibly rich. That isn’t always the case. There are many reasons why parents and guardians would want to create a trust fund, even if they have modest wealth. Here’s how to create a trust for a child and seven mistakes that you should avoid. If you’re considering making a trust for a child, consider getting the help of a financial advisor.
Five Reasons to Create a Trust for a Child
Families create trust funds for their children for many different reasons. While it is good to pass along a lifetime of savings to the next generation, some trusts are created to protect children and take care of their financial, health and wellness needs. These are a few of the most common reasons to create a trust for a child:
Minimize or reduce taxes: Through proper structuring of a couple’s estate, you are able to effectively double the estate tax exemption for assets passed on to your beneficiaries. Also, certain trusts enable investors to avoid taxes on gifts that exceed the annual gift tax exclusion amount.
Avoid probate: When you have a trust, it removes eligible assets from probate court supervision and the fees that the court charges.
Care for special needs children: Children with special needs often need care long after you pass away. Certain trusts can take care of them financially, while also preserving their eligibility for government benefits.
Asset protection: It is possible to shield your assets from judgments and collection efforts with a properly funded trust.
How to Create a Trust for a Child
If you’ve decided to create a trust, here’s how to create a trust for a child in seven simple steps:
Specify the purpose of the trust: What is your primary reason for creating the trust and what do you hope that it will accomplish?
Choose which type of trust: There are many different types of trusts that are effective at handling a variety of financial concerns. They generally fall under the categories of revocable or irrevocable. This decision determines whether or not you can withdraw assets once they’ve funded the trust.
Decide who will manage the trust: The creator of the trust often manages the trust during his or her lifetime, but who will manage the trust once you pass away? It is a good idea to name alternate trustees in case your first choice declines or passes away before you do. The executor carries out the wishes outlined in the trust. They do not have to be the same person.
Select assets that will fund the trust: Depending on your goals and financial situation, you may not put all of your assets into one trust. Some investors have multiple trusts based on how they intend to use their assets.
Create the trust documents: When creating the trust documents think about specific provisions you want to govern when and how your estate is distributed. For example, you may release specific amounts at ages, and life milestones like marriage, pregnancy or earning a degree.
Legally create the trust: Once the trust documents have been created, you’ll formalize the document by signing it and having the appropriate witnesses. Having a third-party notary verify signatures is often a good idea.
Transfer assets into the trust: The trust is not complete until the appropriate assets are transferred into the trust. In most cases, this is a simple title change at the bank or investment company. However, for some trusts, you may have to create new accounts, transfer assets or quitclaim deeds in the name of the trust.
Seven Mistakes to Avoid When Creating a Trust for a Child
Because creating a trust is not something that most investors do regularly, it can be easy to make mistakes. A few of the mistakes that investors make are:
Not working with a professional: While some situations are simple, many can be complex and require an estate planning attorney. Don’t let your estate plan unravel because the template or software didn’t understand your situation or local laws.
Making provisions too restrictive: What seems like a good idea now could be unnecessarily restrictive in the future. Sometimes less is more.
Choosing the wrong trustees: When choosing a trustee, select someone that you can trust and will have your beneficiaries’ best interests in mind. Also, be sure that they won’t be too generous and deplete the assets too quickly.
Giving children full access too early: Many children and young adults are not ready for the responsibility of managing large amounts of wealth at an early age. Consider spreading out their access until a later age or until they’ve met certain milestones.
Designating the wrong beneficiaries: Make sure that beneficiaries on life insurance policies and retirement accounts are titled correctly. In most cases, the trust should be the beneficiary on life insurance, while your spouse or children should be named on retirement accounts. The wrong beneficiaries could trigger a tax bill or eliminate estate planning benefits.
Not reviewing the trust annually: Update your beneficiaries at every life event to ensure that future spouses, children and other family members aren’t left out. The wrong language could exclude your grandchildren from a child who passes away before you do.
Forgetting about college planning: Money that is distributed to children too early may count against them for financial aid. It could exclude them from receiving grants, scholarships or some loans. Discuss this situation with your attorney.
The Bottom Line
Creating a trust for a child is fairly simple and quick. However, deciding what you want to accomplish with the trust may be more complex and take more time. Investors can use trusts to meet different types of goals, so it is important to discuss them with a competent attorney so they can create the right trust documents. As you’re creating the trust, watch out for mistakes to avoid that can derail your carefully crafted estate plan.
Estate Planning Tips
Working with a financial advisor can help you grow your estate to meet your money goals. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have free introductory calls 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.
Growing your estate ensures that you have enough money to handle your retirement expenses and leave money for your beneficiaries. Our investment calculator shows the potential growth of your estate based on your starting point, ongoing contributions, rate of return and time frame.
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