A trust fund is a legal entity created to hold assets for the benefit of individuals or organizations. Trust funds are typically established by individuals who want to give their assets to their children, their grandchildren, or a charity, either during their life or after their death. There are many different types of trusts, and there are several advantages to using a trust fund for estate planning.
What is a trust fund?
What is a trust fund?
A trust fund is a common tool used in estate planning that allows someone to transfer assets to a third party to be distributed to the beneficiaries named on the trust at a later date. Trust funds allow someone to give away their wealth with specific guidelines on how the wealth is disseminated.
There are three parties required to establish a trust fund:
- Grantor: the person(s) placing assets into the trust fund.
- Beneficiary: the person(s) receiving assets from the trust fund.
- Trustee: the person(s) managing the assets in the trust fund.
Benefits of trust funds
Aside from being a useful tool for transferring assets to your loved ones or charitable organizations, trust funds come with several benefits.
- Asset protection: Assets in a trust do not belong to the grantor or the beneficiary; they belong to the trust. If either the grantor or beneficiary is sued, the assets in the trust are protected. Likewise, if there's a divorce, the other party cannot go after the assets in the trust. If someone pursues the grantor or a beneficiary for unpaid debts, the trust fund is still protected.
- Estate tax avoidance: The federal government will tax assets in your estate above a certain threshold. By placing assets into a trust fund, you can minimize the value of your estate, getting below the threshold for estate taxes.
- Control over assets: The grantor is able to control how assets are used and invested in a trust fund. For example, the grantor may want to invest aggressively in stocks. The grantor also decides how and when assets are distributed to beneficiaries, which can protect the assets from a beneficiary who's not yet responsible enough to manage them on their own. For example, a minor may not be granted anything beyond living expenses from the trust until they reach a pre-determined age.
Types of trust funds
There are many different types of trust funds, each with unique characteristics, but they all fall under two umbrellas: revocable and irrevocable trusts.
A revocable trust gives the grantor full control over the assets that go into the trust and how those assets will be distributed. Also known as a living trust (because it can be changed), the revocable trust can be revoked, or closed, at any point during the grantor's lifetime. Once the grantor passes away, it will become an irrevocable trust.
An irrevocable trust cannot be changed once created. This type of trust fund can protect assets from creditors and estate taxes.
Some popular uses for trust funds include:
- Retirement savings: 401(k)s and IRAs are technically trust funds. If you have a 401(k) at work, it's a trust fund that you and your employer put assets into, and you are the named beneficiary.
- Charity: Someone might set up a charitable trust fund to benefit specific organizations after they die or while they're still alive. A charitable trust can be used for tax planning, taking the itemized deduction in one year and distributing the funds to charities over many years in the future.
- Special needs: A person with special needs who receives government benefits like Medicaid or Supplemental Social Security income must keep their assets below a certain threshold. A trust fund can be used to ensure a disabled person can still receive those benefits.
There are many more types of trusts and estate planning strategies used to maximize the value of assets and pass on wealth to the people you care about. This is just the tip of the iceberg.
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A fiduciary is someone who manages money, assets, or property for a client or beneficiary.
Why use trust funds?
Why do people use trust funds instead of a will?
If you simply want to leave money to your children or grandchildren, you could write them into your will. Still, many people use a trust fund because they offer valuable advantages over a will.
One of the biggest benefits is that a trust fund can avoid probate, where the court authenticates your will and approves the executor so they can distribute your assets. An irrevocable trust fund allows for the immediate distribution of wealth to beneficiaries upon certain events, such as your death.
Unlike wills, a trust fund is private. Only the trustee and beneficiaries will know how you want to distribute your assets after death.
Trusts are also capable of including assets held in retirement plans or life insurance policies. Those aren't covered by wills.
Lastly, you can specify how you'd like an asset to be used in a trust. For example, you can specify that the beneficiary receives a certain amount of cash in distributions every year. Or you could say your spouse gets to live in your house until they pass, and then it belongs to the children.