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trust fund

There are many ways to set up a financially secure future for your loved ones. You could enlist the help of a financial advisor to come up with a comprehensive financial plan. Trust funds are another way to set your children or grandchildren up for future financial success. And they aren’t just for the very wealthy. You can open a trust fund to ensure your loved ones manage and distribute your assets in a specific way, regardless of your net worth.

What Is a Trust Fund?

A trust fund is a legal entity that holds property or assets on behalf of another person, group or organization. It is an estate planning tool that keeps your assets in a trust managed by a neutral third party, or trustee. A trust fund can include money, property, stock, a business or a combination of these. The trustee holds onto the trust fund until the time comes to pass the assets on to your chosen recipients.

Trust funds provide for more control and specificity than a will does. This is because when you die, your will becomes public record and there’s not always a guarantee your wishes will be met. With a trust fund, only the trustees and the beneficiaries know the contents and conditions of the fund. Additionally, certain trust funds can protect your assets from legal action and provide tax benefits.

How Does a Trust Fund Work?

There are three parties involved in a trust fund: the grantor, the trustee and the beneficiary. The grantor is the person who establishes the trust fund and places his or her assets into the fund. The trustee is the person or institution who holds and manages the assets. Finally, your beneficiary is the person you’ve chosen to receive the fund’s assets.

To set up a trust fund, the grantor works with a lawyer to create the trust. You can also choose a financial advisor to work with to help you allocate your assets in the best way. The grantor names the trustee, often a family member or a financial institution. A grantor must also name the beneficiary like their children or grandchildren, a business partner or a charity. The grantor and the lawyer also draw up the terms of the trust fund. The terms include which assets the grantor will include and how they want those assets to be distributed.

Trust funds differ from other estate planning tools. They enable the grantor to provide specifications for how and when the beneficiary will receive the trust’s assets. For example, as a grantor, you may choose to pay out funds annually to the beneficiary or as a lump sum once the beneficiary reaches a certain age. The grantor can even specify the funds go towards a significant expense like college tuition or a down payment on a house.

A common inclusion in a trust fund is a “spendthrift clause.” This prevents a beneficiary from using the trust fund’s assets to pay off their debts. So even if your grandson were to gamble away all his own money and incur a ton of debt, his creditors can’t touch his trust fund. That way, your grandson can still have some backup money to help him get back on his feet.

Different Types of Trust Funds

trust fund

There are a few types of trust funds. For starters, there are irrevocable trust funds which once established, are unchangeable. As the grantor, you cannot rescind the trust nor change the terms or distribution. This rigidity comes with some benefits. First, because the grantor no longer owns the assets, they don’t need to pay income tax on money made by these assets. Funds an irrevocable trust no longer count as part of the grantor’s estate. Therefore, moving assets into an irrevocable trust can also help the grantor move into a lower tax bracket or avoid paying estate tax. Irrevocable trusts also protect funds from legal claims and debts against the grantor. This way, the beneficiary can still benefit from those assets in the event the grantor falls into debt or hardship.

Revocable trust funds, on the other hand, can be changed at any time. These are also called living trusts. You can update them as needed by adding or removing assets and beneficiaries. You can even dissolve the fund which results in returning the assets to the grantor. This allows for more flexibility and control, as changes can be made until the grantor dies. However, unlike an irrevocable fund, the funds within a revocable trust are still considered part of the grantor’s estate. This leaves them less protected if the grantor faces legal claims, medical bills or other debts. In this case, the funds in the revocable trust can be seized.

A charitable remainder trust is another type of trust fund. Also called a charitable annuity trust, this allows you to pass on your assets to a specified charity instead of a relative. The assets within this kind of fund provide a fixed-percentage income for the beneficiary during the life of the trust. When you fund a charitable remainder trust, you can immediately benefit from charitable-contribution tax credits. Plus, you’re donating your assets toward a great cause.

Who Needs a Trust Fund?

You’ll find trust funds useful if you want to leave money, property or other assets to someone else and ensure their use in a specific and incontestable way. You can set up a trust to pay out assets at specific times, like annually, for specific events like at graduation, or at a certain age. If you want to make sure your wealth lasts longer, you can choose to have it paid out to your beneficiaries in installments rather than a lump sum. If you want to pay for your grandchildren’s education, you can have it paid out for their tuition only.

Trust funds also combat some of the issues you might face with a will. Unlike a will, trusts are not subject to probate, the legal process that verifies your will. Since the assets in the trust belong to the trust, not the grantor, there’s no need to transfer ownership of those assets upon the grantor’s death. Without probate, trusts also keep your estate dealings private.

The Bottom Line

A trust fund offers a solid estate planning tool for those who want more control over their assets than a will can provide. Trusts allow the grantor, the person setting up the trust, to define the terms of the trust. This includes how and when you want the contents of the trust to be passed on to the beneficiaries. Irrevocable trust funds also provide some tax benefits and protection of their assets from legal action.

Tips on Planning for Retirement

  • If you’ve decided you want to open a trust fund, it’s important that you have enough money for both the fund and yourself. Sure, it’s great to set up your child with their college tuition, but don’t forget about funding your retirement too. Open up savings accounts like an IRA or 401(k) to get your retirement savings started.
  • You might find that navigating your finances and assets, especially when setting up funds and accounts, is a lot to handle on your own. In that case, it could really help to have a financial advisor to guide you as you manage your finances. They can help you maximize your savings and get some great tax benefits, too. SmartAsset’s financial advisor matching tool makes it easy to find an advisor to work with who meets your needs. Simply answer a short questionnaire and then we’ll pair you with up to three advisors in your area.

Photo credit: ©iStock.com/simarik, ©iStock.com/SIphotography, ©iStock.com/Chris Ryan

Danielle Klimashousky Danielle Klimashousky is a freelance writer who covers a variety of personal finance topics for SmartAsset. She is an expert on topics including credit cards and home buying. Danielle has a BA in English from Wesleyan University.
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