A trust fund is a financial tool where an individual can store assets for the benefit of another person or organization. If you’re in the process of planning your estate, you might be considering a trust fund to secure your family’s financial needs.
They might be a popular option, but few people know all the ins and outs of trust funds, how they work or the advantages and disadvantages they offer. Let’s take a closer look at trust funds and find out whether they’re the best option for you and your loved ones’ financial future.
What Is the Point of a Trust Fund?
As an essential piece of estate planning, trust funds help families ensure their assets can be passed down, providing financial support for their loved ones, while keeping those assets protected.
Real estate, stocks, family heirlooms and liquid assets can all be held by a trust fund, which usually requires an estate planning attorney to establish. Your attorney can help set the parameters for your trust fund and define the circumstances that must be met for beneficiaries to receive the assets.
These stipulations help the creator of the trust establish where, when and how their assets will be distributed – while creating legal requirements that define when the trust should be released. For example, if a grandparent sets up a trust for their grandchild, they can include a condition that the grandchild must graduate college before they can receive the assets.
Trusts might also be used to reduce the level of taxes required on held assets. Depending on the type of fund being used, assets held in a trust might be shielded from certain estate taxes that would otherwise eat into the beneficiary’s inheritance.
Like most things in the financial world, setting up a trust fund can get complicated. Let’s take a closer look at how a trust fund works and whether it’s the best option for your long-term goals.
How Does a Trust Fund Work?
Generally, there are three parties involved in creating a trust fund:
- Grantor: This is the individual who sets up the trust fund. Working with an attorney, the grantor decides which assets to include in the trust and under what conditions those assets are to be released.
- Beneficiary: The beneficiary is the person, people or organization the trust is set up for. Beneficiaries come into ownership of the trust’s assets when the conditions defined by the grantor are met.
- Trustee: The trustee acts as an impartial manager of the trust fund. If the grantor becomes incapacitated or passes away, the trustee is responsible for ensuring the trust is handled according to the grantor’s wishes.
When the grantor decides to open a trust fund, they’ll work with an attorney or financial professional to decide which assets go where, and what checkpoints must be reached for the beneficiary to receive them.
As discussed above, these funds can protect assets from certain estate taxes when the grantor passes away. Similarly, if the grantor has unpaid debts, storing assets in a trust fund may shield them from creditors, ensuring the beneficiary receives their inheritance in full.
Trust funds also alleviate some of the legal complications that can come when a family member passes away, such as probate court. Probate can be an expensive legal process that validates an individual’s will and determines how it should be executed. If there’s no will, probate court decides how their estate will be distributed – but usually for a much higher price tag.
Some trust funds avoid the need for probate by providing a clearly defined representation of the grantor’s wishes. This allows for a quick distribution of assets without extra legal costs.
What Are the Types of Trust Funds?
Depending on what you’re looking to achieve with a trust fund, one type might be a better fit than another. Here’s a look at the most common types of trust funds and some advantages they provide.
Perhaps the most common type of trust fund, living trusts are used to specifically lay out what should happen to an individual’s assets when they pass away.
These legal arrangements are decided by the grantor, who provides instructions on how and when their family members will receive funds, stocks or property that’s been added to the trust. The grantor then designates a trustee to manage the fund until the conditions for distribution are met.
A major benefit of living trusts is that they help avoid the expensive and time consuming probate process, which can quickly dilute the beneficiary’s inheritance. By installing a living trust, there won’t be any need for further certification, and the trustee can distribute assets as the grantor sees fit.
When opening a living trust fund, you’ll need to decide on a revocable or irrevocable trust:
- Revocable trust: In a revocable trust, the grantor continues to manage any assets placed in the trust while they’re still alive. When the fund is first established, the grantor has the right to name themself as trustee, giving them the option to amend the conditions of the trust at any time.
- Irrevocable trust: As the name suggests, irrevocable trusts can’t be amended as easily. When assets are placed in an irrevocable trust, ownership transfers to the fund itself, with the grantor unable to make changes unless pre-established conditions are met.
Life insurance trusts
An irrevocable life insurance trust (ILIT), helps the grantor define how funds from insurance policies should be distributed after the policy holder’s death. As an irrevocable type of trust fund, the grantor won’t have control over the insurance policy once the trust is established.
With a typical life insurance policy, a single beneficiary receives the payout when the insured person passes away. With ILITs, the grantor can legally define how funds are distributed, who receives them and how those funds should be used.
Since life insurance trusts are irrevocable, the grantor doesn’t have ownership over the policy. Ownership of the policy falls to the trust itself. Therefore, when the grantor dies and the policy is paid out, those funds don’t count toward inheritance taxes, alleviating some of the financial burden for the beneficiary.
If you’re married and share assets or property with your spouse, a joint trust might be a viable option when planning your estate. With a joint trust, both parties act as the grantor and specify what should happen to held assets should one of them pass away.
This way, couples can simplify the inheritance process by avoiding having to divide assets from multiple trust funds. Unlike life insurance trusts, joint trusts are revocable. This means each spouse can amend the agreements as they see fit, even after the rules of the fund have been established.
When one spouse passes away, the surviving spouse either becomes the trustee or has the assets passed to them according to these rules.
Pros and Cons of a Trust Fund
Estate planning can be complicated, and maybe you’re not sure if a trust fund is the best option for your family. Let’s take a look at some of the pros and cons of a trust fund for a clearer picture on what they offer.
When a family member passes away, probate court can be a difficult and expensive process – especially after the loss of a loved one. Trust funds eliminate the need for probate court by settling the grantor’s wishes before they pass away.
When you establish a living trust, you can rest assured your family will get financial support after you’re gone. By establishing conditions like age restrictions, you can be sure younger family members have access to funds only when they’re ready to manage them.
Certain trust funds provide major financial advantages that protect beneficiaries from estate and inheritance taxes. For example, with an irrevocable trust, ownership of the assets is assigned to the trust account, rather than the grantor. Therefore, assets that get passed can’t qualify for certain estate taxes.
If you opt for an irrevocable trust fund, changing the conditions of that account can be complicated. When you deposit an asset to this account, you relinquish ownership and will have a difficult time amending conditions you previously established.
Without a deep understanding of the different types of trust funds, building one can be complicated. Once the trust is established, it might be hard to control or manage assets held within it.
Trust funds are a financial tool that can be costly and time consuming to establish. If the fund costs you $10,000 in legal fees to set up, and you can only add $30,000 worth of assets, a trust fund might not be the best way to plan your estate.
How to Set Up a Trust Fund
Depending on what type of trust fund you’re looking to open, the process for setting one up might differ from another. That said, there are a few general steps that follow the same pattern:
- Decide on a beneficiary: Get an idea of who the beneficiary, or beneficiaries, of your trust will be.
- Decide on a trustee: Select an independent trustee to oversee the trust’s execution. In some cases, the grantor is able to select themself as trustee and establish a successive trustee in the event the grantor passes away.
- Choose what assets to include in the trust: Before opening a trust, it’s important to have an idea of which assets you plan on depositing into the account.
- Set inheritance parameters for the trust: One of the major benefits of a trust fund is the ability to set parameters around the assets’ distribution. Begin the trust fund process with an idea of what rules should apply and when these assets can be distributed.
- Work with an estate attorney: Setting up a trust is a complex process that requires the work of a professional. Be sure to work with an experienced estate attorney who can carry out your trust fund objectives.
Can a Beneficiary Borrow Money From a Trust?
If you’re the beneficiary of a trust, you might be curious as to whether you can withdraw some of those funds. If the conditions of the trust’s distribution haven’t been met, you’ll have a tough time doing so.
For a trust loan to be approved, the trustee must sign off on that form of financing. By law, the trustee is responsible for servicing the trust impartially, ensuring all beneficiaries receive their entitlements fairly and in accordance with the grantor’s wishes. To approve a loan or withdrawal outside of the trust’s stipulations would be a breach of this fiduciary responsibility, and these types of loan are rarely approved.
Securing Your Family’s Future
With enough assets and a good amount of planning, a trust fund can be one of the best options for securing your family’s future. By protecting these assets from certain taxes and creditors, you can rest assured your loved ones will receive their full inheritance in exactly the way you see fit.