Trust Funds and How They'll Work For You

Trust Funds and How They’ll Work For You

How Trust Funds Work

How Trust Funds Work

Investments (MP) Whenever you hear the label “trust funds (TFs)” it usually reminds you of wealthy born individuals whom inherited lots of money, however, trusts aren’t just for the rich.  TF’s are used to control and administering assets for the benefit of children but may also benefit groups or organizations.   But, often they’re created for your children’s benefit (thus the term “trust fund babies”), or for older family members who can’t manage their own money.

The strategy begins the moment the originator (you), or the original donor, provides the money for the monetary funds to start up. The fund managers then step in the fund, investing it and growing it, ensuring that it simply makes more money. The beneficiary (your child), individual the trust was created for, will be given certain amounts of money from the fund on regular dates to look after his or her needs. The beneficiary must comply with the terms and conditions of the TFs in order to keep receiving money.

You could be the beneficiary of a fund, or you might be contemplating setting one up for your own heirs. Either way, trusts are simply  defined as the assets held in a trust and any income they produce.  Let’s get more understanding…

What is Trust Funds?

A TF is a special type of legal entity which holds property for the benefit of another person, group, or organization. There are various types of trusts, and many different provisions that modify how they work. Ordinarily, all of these money protecting vehicles have three important parties:

The Grantor: This is the person who establishes the fund, donates the property (such as cash, stocks, bonds, real estate, mutual funds, art, a private business, or anything else of worth) into the account, and who decides the terms on which it has to be managed.

The Beneficiary: This is the person(s) for whom the fund founded. In fact it’s intended that the assets inside the account, though not owned by the beneficiary, will be managed in a manner that will benefit him or her, adhering to the specifics by the grantor when the fund was made.

The Trustee: This can be a single individual, an institution (such as a bank trust department that appoints one of its staff to the responsibility), or multiple trusted advisors. They’re in charge of overseeing that the money, maintains its duties, the documents and applicable law. The trustee is often paid a minor management fee. Some documents give responsibility for managing the assets to the trustee, while others require the trustee to choose qualified investment advisors to orchestrate the funds.

What does a trust do?

These instruments can be a fantastic way to cut the tax you’ll pay on your inheritance, but you should seek professional advice. However, for a brief understanding, when a TFs earns income or if the sale of assets produces capital gains, somebody has to pay taxes on the income earned. With a revocable trust, it’s the grantor, at least during his lifetime. His fund becomes a separate tax entity when he dies. An irrevocable trust is a separate tax entity from its inception, therefore it typically pays its own taxes on capital gains and income.

Exceptions exist for distributions – these are taxable to the beneficiaries, and the TF might take an income tax deduction for each distribution. Revocable trust funds are subject to estate tax because the grantor never gave up control over their assets. Irrevocable TFs are not.

The moment you put assets into this account they do not belong to you anymore. This means that when you die their value normally won’t be counted against your Inheritance Tax bill. Instead, the cash, investments or property belong to the trust and is controlled by the trustee, who has a legal duty to look after the assets for the person(s) you originally named the beneficiaries of the document. When you set up the document you decide the rules about how it’s managed – for example, you might say that your children will get access to their money when they are 21.

Types of trusts

There are two basic types of trusts: living trusts and testamentary trusts. A living trust or an “inter-vivos” trust is set up during the person’s lifetime. A Testamentary trust is set up in a will and established only after the person’s death when the will goes into effect.

Living trusts can be either “revocable” or “irrevocable.” Revocable trusts let you retain control of all the assets in the trust, and you’re free to revoke or alter the rules of the trust whenever you like.With irrevocable trusts, the assets in it are no longer yours, and typically you can’t make changes without the beneficiary’s consent. But the appreciated assets in the trust aren’t subject to estate taxes.

Here are  more complicated types of trusts that apply to specific situations:

Credit shelter trusts: With a credit-shelter trust (also called a bypass or family trust), you write a will bequeathing an amount to the fund, up to but not exceeding the estate-tax exemption. You then roll the rest of your estate to your spouse tax-free. And there is another bonus: Once funds are placed in a bypass trust, it is forever free from estate tax, even when it grows.

Generation-skipping trusts: A generation-skipping TF (also called a dynasty trust) allows you to transfer a substantial amount of money tax-free to beneficiaries who are at least two generations your junior – typically your grandchildren.

Qualified personal residence: A qualified personal residence trust can remove the value of your home or vacation dwelling from your estate and is particularly useful if your home is likely to appreciate in value.

Irrevocable life insurance: An irrevocable life insurance trust can remove your life insurance from your taxable estate, help pay estate costs, and provide your heirs with cash for an array of uses. To remove the policy from your estate, you surrender ownership rights, meaning you may no longer borrow against it or change beneficiaries. In return, the proceeds from the policy may be used to pay any estate costs when you finally die and gives your beneficiaries tax-free income.

Qualified terminable interest property: If your family has endured divorce, remarriages, and stepchildren, you may wish to direct your assets to particular relatives through a qualified terminable interest property trust. Your surviving spouse will receive income, and the beneficiaries you specify (e.g., your children from a first marriage) will get the principal or remainder after your spouse dies.

How to create Trust Funds

Trusts become manifest when the trustor defines the terms of the trust in writing. The document that contains the terms is typically known as the trust instrument, declaration of trust, or deed of trust. With a testamentary trust, the terms are included in the trustor’s last will and testament, while a living trust usually requires its own trust instrument.

The sort of information a trustor has to include in the trust instrument differs slightly based on the type of fund being created and the trustor’s specific wishes, but there are some details that all such account instruments need to include:

1. Name Your Trust. The instruments typically begin with a statement declaring the trustor and what the trust is called. For example, As a Trustor I created a revocable living trust and called it the “The Briscoe Family Living Trust.”

2. Describe It. A document or instrument usually includes a description of the type of trust being created, and the reason the trustor is creating it. For example, the trustor might state that he or she is creating a special needs trust to provide support for his child with disabilities.

3. Beneficiary. The document must name who will be its’ beneficiary or beneficiaries. The instrument should also include specific directions about where monies should be dispersed in case of death of all beneficiaries

4.  Trustee’s Duties. The fund must name who will serve as trustee. Many of the trust’s terms address what the trustee can and cannot do. These terms address issues such as the trustee’s ability to buy or sell property, the ability to distribute property to the beneficiary, and what the trustee must do to resign or transfer trustee responsibilities to someone else. In the event the original trustee is no longer able or willing to serve, who will be their replacement(s).

5. Trust Property. Most instruments include a list of property owned. The property (known as the trust corpus) list can be included in the instrument, or referred to as a list to be attached or included with the instrument.

6. Death. Many accounts include terms that address what happens if the trustor, trustee, or beneficiaries die or become incapacitated. For example, if the trustor creates a revocable living trust, the trust will direct the successor trustee to distribute the property that it owns to inheritors.

For more on setting up a trust funds see Suze Orman.

Don Briscoe
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Don Briscoe

Finance educator, advisor, and leading voice in the global financial literacy movement.Founder and editor of MoneyPacers.com.He lives and enjoys life with his family in New York.
Don Briscoe
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