A trust fund is a legal arrangement in which assets are held by one party — called the trustee — for the benefit of another party — called the beneficiary. The term trust fund is often used informally to refer to any type of trust but technically it refers to the assets held within a trust rather than the trust itself.
Trust funds are used for a wide range of purposes including estate planning, protecting assets for minor children, providing for family members with special needs, charitable giving, and protecting assets from creditors. Despite their reputation as tools for the wealthy trust funds can be useful for people of modest means as well.
How a trust fund works
When a person — called the grantor or settlor — creates a trust they transfer ownership of assets into the trust. Those assets are then managed by the trustee according to the terms of the trust document for the benefit of the named beneficiaries.
The trust document — sometimes called the trust agreement or declaration of trust — specifies:
- Who the trustee is and who succeeds them if they are unable to serve
- Who the beneficiaries are
- What assets are held in the trust
- How and when assets can be distributed to beneficiaries
- What happens to remaining assets when the trust ends
The trustee has a legal duty — called a fiduciary duty — to manage the trust assets prudently and in the best interests of the beneficiaries according to the terms of the trust.
Types of trust funds
There are many types of trusts that can hold a trust fund. The most common include:
- Revocable living trust — created during the grantor’s lifetime and can be changed or canceled at any time. Commonly used to avoid probate and plan for incapacity.
- Irrevocable trust — generally cannot be changed once created. Used for asset protection, Medicaid planning, and estate tax reduction.
- Testamentary trust — created by a will and takes effect after the grantor’s death. Commonly used to manage assets for minor children until they reach adulthood.
- Special needs trust — holds assets for a person with a disability without disqualifying them from government benefits
- Spendthrift trust — protects a beneficiary’s inheritance from their own creditors or poor financial decisions
- Charitable trust — benefits a charitable organization either during the grantor’s lifetime or after death
- Education trust — holds assets specifically designated for a beneficiary’s educational expenses
Trust funds for minor children
One of the most common uses of a trust fund is to hold assets for minor children. Minor children cannot legally manage significant sums of money and if assets are left directly to a minor child a court may need to appoint a guardian to manage the funds until the child reaches adulthood.
A trust fund solves this problem by placing assets in the care of a trustee who manages them on behalf of the child until they reach a specified age. The trust document can specify:
- At what age or ages the child receives distributions
- What the funds can be used for — such as education, health, or general support
- Whether the trustee has discretion to make distributions based on the child’s needs
Many parents choose to distribute trust assets in stages — for example one third at age 25, one third at age 30, and the remainder at age 35 — rather than all at once to protect against poor financial decisions by a young beneficiary.
Trust funds and probate avoidance
One of the primary advantages of a revocable living trust fund is that assets held in the trust avoid probate — the court supervised process of validating a will and distributing an estate. Because trust assets are owned by the trust rather than by the grantor personally they pass directly to beneficiaries without court involvement when the grantor dies.
This can save significant time and expense and keeps the distribution of assets private. Probate proceedings are public record but trust distributions are not.
Trust funds and taxes
The tax treatment of trust funds depends on the type of trust:
- Revocable living trust — because the grantor retains control of the assets they are included in the grantor’s taxable estate and income is reported on the grantor’s personal tax return
- Irrevocable trust — assets transferred into an irrevocable trust are generally not included in the grantor’s taxable estate. The trust files its own tax return and pays taxes on income at trust tax rates which can be higher than individual rates.
- Testamentary trust — created at death so assets are included in the grantor’s estate for estate tax purposes. The trust files its own tax return after it is created.
Who should be the trustee
Choosing the right trustee is one of the most important decisions in creating a trust fund. The trustee is responsible for managing trust assets, making distribution decisions, filing tax returns, and fulfilling all legal obligations to the beneficiaries.
Options for trustee include:
- A trusted family member or friend who is financially responsible
- A professional trustee such as a bank or trust company
- An attorney or accountant familiar with trust administration
- A combination of an individual co-trustee and a professional co-trustee
For trusts that will last many years or involve significant assets many families choose a professional trustee or co-trustee to ensure proper management and continuity.
How to create a trust fund
Creating a trust fund involves working with an estate planning attorney to:
- Determine the type of trust that best meets your goals
- Draft a trust document that reflects your wishes and complies with your state’s laws
- Sign the trust document before a notary
- Fund the trust by transferring assets into it — this step is essential and often overlooked
- Update beneficiary designations on financial accounts and insurance policies to coordinate with the trust
Common misconceptions about trust funds
- Trust funds are only for the wealthy — trusts can be useful for people of modest means especially those who own real estate or want to provide for minor children or family members with special needs
- A trust replaces a will — most people with a trust still need a pour-over will to capture assets not transferred into the trust and to name a guardian for minor children
- Trusts are too complicated — while trusts are more complex than a simple will a good estate planning attorney can explain the process clearly and handle the technical details
Key terms to know
- Trust fund — the assets held within a trust
- Grantor or settlor — the person who creates and funds the trust
- Trustee — the person or organization that manages the trust assets
- Beneficiary — the person or organization that receives benefits from the trust
- Fiduciary duty — the legal obligation of a trustee to act in the best interests of the beneficiaries
- Testamentary trust — a trust created by a will that takes effect after death
- Spendthrift trust — a trust that protects a beneficiary’s inheritance from creditors and poor financial decisions
- Pour-over will — a will that directs assets outside the trust into it upon death
Sources
- American Bar Association — Public Resources
- Internal Revenue Service — irs.gov
- USA.gov — Estate Planning
- National Institute on Aging
This article is for general informational purposes only and does not constitute legal or financial advice. Trust laws vary by state and are subject to change. Consult a licensed attorney for guidance specific to your situation.