You've probably heard the term "trust fund," but it might only conjure images of irresponsible "trust fund babies" partying on yachts in the Mediterranean. There is far more to trust funds than that, though. For many people with a wide range of incomes, a trust fund can be a wonderful estate planning tool.
A trust, or trust fund, is simply a vehicle to transfer assets, and it's especially useful for people with children who are still minors or for those who would like some of their assets to go to their beneficiaries without the hassle of probate.
On probate, wills, and privacy
Probate is a legal process applied when someone dies. It involves validating the decedent's will and then granting power to its executor. Wills are sometimes contested during the probate process. The probate process can also be lengthy, often taking two to eight months for beneficiaries to receive their inheritances. Conversely, trusts do not go through probate and beneficiaries can benefit quickly.
Another important point to note is that wills, though private while you're alive, are eventually filed with probate court and become part of the public record. Thus, if you'd like to keep more of your business away from prying eyes, you should consider a trust. It can't always keep everything concealed, due to prevailing laws, but it's much more private than going through probate.
The trust concept
So how does a trust work? Think of it as a box into which you put some of your assets, intending for them to eventually go to another party, the beneficiary. The beneficiary or beneficiaries can be one or more people, or even an organization such as a charity, and it can even be yourself if you think you might not be able to manage your own finances at some point.
The assets in the trust are managed by one or more trustees, which might be a trust management arm of a financial company. As the "grantor" or "donor," you offer instructions regarding how the assets will be managed and later discharged. Beneficiaries might get it all as a lump sum or in installments.
As you might suspect, there are many rules and things to know about trusts. If you decide to establish one, you will absolutely need to consult a lawyer who specializes in trusts and estates, and probably use one to set up the trust, too.
Kinds of trusts
Trusts come in two main types -- the living trust and the testamentary trust -- and the type you use depends on whether your heart is beating at the time it's set up. You create a living trust during your lifetime, and you might also be able to tweak or cancel ("dissolve") it. A testamentary trust is created through your will after you die, so it's irrevocable.
Some trusts can be set up to help you manage gift-giving. For example, currently, you can give up to a certain sum of money each year (the maximum is $14,000 in 2015) to each of as many people as you want, without any tax consequence. But if you want to give more, there are tax considerations. If you pass assets to others through a trust (which will likely have to be irrevocable, even though you're alive), they will likely be taxed upon receipt of the assets. But you can control when the beneficiary receives them, and thereby manage the tax issue, deferring taxation.
You can establish a trust in which the beneficiary is also the trustee, deciding how to invest the assets, or one in which the trustee uses the assets to care for the beneficiary. There are many other kinds of arrangements, too, such as trusts that provide for the care of pets after the owner dies.
Pros and cons, and a word of caution
A main drawback to trust funds is their cost, which can run about $1,000 to several thousand dollars. (A will, on the other hand, usually costs just a few hundred dollars.) You also, ideally, should have a certain amount of... trust... in the parties involved. Your trustee(s) should be trustworthy enough to manage the assets well, and the beneficiaries trustworthy to receive them.
You might also just not need a trust fund. If you're married, your surviving spouse will inherit many assets automatically, and so will designated beneficiaries for many things, such as life insurance policies and pensions. You might not need much privacy, either, or not find the length of the probate process a problem. You can accomplish many of your goals, and perhaps all of them, with a will.
Finally, be wary if you're approached by anyone who tries to get you to set up a trust, as some scams work that way. It's best to do your own research and find the necessary professionals on your own, perhaps via references from friends.
A trust fund isn't for everyone, but it's also not just for the wealthy. Give some thought to your needs and those of your loved ones and see whether a trust makes sense for you.
Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, has no position in any stocks mentioned. She can't serve as your trustee, but she'd be delighted to be a trust beneficiary. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.