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A trust fund is a legal entity that holds property or other assets on behalf of a person, a group of people or an organization. Trust funds are commonly used as estate planning tools to protect certain assets and ensure that your wishes regarding them are carried out.
Trust funds are often associated with high-net-worth individuals, but anyone can set one up. Here's what you should know about how they work, reasons to consider having one and the next steps you can take.
How Do Trust Funds Work?
A trust fund is designed to ensure that a person's assets are held and managed for the benefit of another person, group of people or organization, with the assistance of a third party. There are three key parties to a trust fund: the grantor, the trustee and the beneficiary.
- Grantor: The person that sets up the trust fund and places their assets in it. The grantor also creates the rules for how the assets within the fund are managed, accumulated and distributed.
- Trustee: A third party who is tasked with managing the trust fund. The trustee has a fiduciary duty to the beneficiaries of the trust, which means they must act in the beneficiaries' best interests within the terms set by the grantor. A trustee can be any person or firm the grantor chooses.
- Beneficiary: The beneficiary of a trust fund can be an individual, a group of people or an organization. The grantor designs the trust for their benefit.
Trust funds work differently from many other estate planning tools because they make it possible for the grantor to decide when and how their beneficiaries receive the assets meant for them.
For example, a grantor may choose to pay the beneficiary a set amount annually or provide a lump-sum payment when they reach a certain age. The grantor may also specify how the funds can be used, such as for college expenses or a home down payment.
The grantor may even prohibit certain uses of the trust fund assets. A common provision is the spendthrift clause, which prevents the trustee from distributing money to the beneficiary to pay off debts.
Finally, a trust fund provides some protection for the assets within the trust. The property in the trust doesn't go through the probate process after the grantor dies, which can be time-consuming and expensive. Also, depending on the type of trust you set up, the assets the grantor places in it may be protected from their creditors.
Types of Trust Funds
There are several different types of trusts you can set up, and each provides unique features to meet various needs.
- Irrevocable trust: Once assets are placed in an irrevocable trust, the grantor no longer has control over them, and it can be difficult to make changes or revoke the trust. Because the grantor no longer controls the assets, they are protected from the grantor's creditors.
- Revocable trust: This type of trust allows the grantor to continue to control the assets during their lifetime. It's also often called a living trust, and the grantor can make changes to or revoke the trust at will. Assets in a revocable trust fund aren't protected from creditors.
- Blind trust: With a blind trust, the beneficiary is unaware of who holds the power of attorney to the trust fund.
- Charitable trust: This trust allows the grantor to make donations to a charitable organization as they see fit.
- Generation-skipping trust: Specifically designed to benefit a grandchild of the grantor.
- Special-needs trust: Created for a beneficiary who has special needs. The assets received by the beneficiary from the trust don't disqualify them from government benefits.
Work with an attorney or financial advisor to discuss the different types of trusts that may apply to your situation and which one is the best option for you and your beneficiaries.
Reasons to Use a Trust Fund
With so many trust fund options available, there are several reasons to consider using one in your own estate planning. Here are some of the top benefits trusts provide:
- Tax planning: Some states impose some form of inheritance or estate tax, which may reduce some of the assets you leave to your loved ones. A trust fund can protect certain assets from these taxes.
- More control: The grantor gets to stipulate exactly how the assets in the trust should be managed, accumulated and distributed. Also, hiring a professional third-party trustee can prevent arguments among family members.
- Privacy and avoiding probate: Once you die, your will goes through the probate process, making the document public for anyone to view. What's more, probate can be a very time-consuming and expensive process. A trust fund may help you avoid the entire process.
- Asset protection: With some trust funds, your assets in the trust are protected from your creditors. And depending on how you create the rules for the trust, it could also protect them from irresponsible actions by your beneficiaries.
- Charitable giving: A charitable trust makes it possible to create a long-term plan to donate your assets to a cause you care about the way you want, even long after you're gone.
- Special-needs planning: If you care for someone with special needs, a special-needs trust allows you to ensure their continued support after you die, without impacting their ability to receive government benefits.
Depending on your situation, you may also be able to take advantage of other benefits some trusts provide. While many of these scenarios may not occur for some people, it's still a good idea for anyone who's concerned about how their assets or life insurance proceeds will be used after their death to consider a trust fund.
Seek Professional Help to Draft a Trust
It's not always necessary to hire a trust attorney to draft a trust, but it's recommended. This is because an attorney understands all the ins and outs of the legal requirements to create one.
Also, an attorney can help by learning about your situation and recommending the right trust to best suit your needs, whether that's to minimize taxes, provide for your heirs, protect assets, make charitable donations or whatever else.
The cost of hiring a trust attorney can vary depending on the type of trust and your needs, but you can generally expect to pay at least $1,000.
If you're planning to hire an attorney, do an internet search for estate planning and trust attorneys in your area. You'll be able to read reviews from past customers and contact the office to find out about costs. Some websites, including Lawyers.com and FindLaw, can help you narrow down your list of options based on your specific needs.
If Now Isn't the Right Time, Keep It in the Back of Your Mind
Now may not be the right time to set up a trust. But that doesn't mean it'll never be in the cards. As your financial situation and goals change over time, keep in mind that you may want to use a trust in the future as part of your estate planning. When that time comes, do your due diligence to understand how a trust can serve your needs and where to go to get one set up.