Understanding Trust Funds: Points to Ponder
1. What is a Trust Fund?
A trust fund is a legal agreement in which an individual (the “grantor” or “settlor”) gives assets (e.g., money, property, or investments) to a trustee, who holds and distributes the assets based on the terms of the trust agreement. The trust is established for the benefit of a beneficiary (or beneficiaries), who will get the assets or income from the trust, either during their lifetime or upon the occurrence of a specific event.
2. Types of Trust Funds
There are a number of different types of trust funds, each of which is intended to perform a distinct function:
- Revocable Trust: Also referred to as a living trust, this is one that can be changed or revoked by the grantor at any point up until their passing.
- Irrevocable Trust: This is one that cannot be changed or terminated once it’s been created unless the beneficiaries agree.
- Testamentary Trust: Established in a will and takes effect after the grantor passes away.
- Charitable Trust: Intended to be for the benefit of a charitable institution or cause, and giving tax deductions to the giver.
- Special Needs Trust: Created to cater to an individual with disabilities without impacting their qualification for government benefits programs.
- Spendthrift Trust: Serves to shield the assets from being wasted by the beneficiary, especially in situations where the beneficiary is not fiscally responsible.
3. Major Parties in a Trust Fund
- Grantor (Settlor): One who establishes the trust and moves assets to it.
- Trustee: The person or organization who is entrusted with the management of assets in the trust. They owe a fiduciary obligation to act for the benefit of the beneficiaries.
- Beneficiaries: The people or organizations who are to be benefited by the trust. They get assets or income from the trust as per the terms.
4. Purpose of a Trust Fund
Trusts are established for many different purposes, including:
- Estate Planning: A trust fund permits the grantor to specify how their property is to be distributed upon death, so that their intent is fulfilled.
- Asset Protection: A trust may protect assets from creditors, lawsuits, or divorces.
- Reducing Taxes: Some trusts, such as irrevocable trusts, may eliminate estate taxes by taking assets out of the taxable estate of the grantor.
- Supporting Dependents: Trusts may be set up to support the financial requirements of children, spouses, or relatives, including individuals with special needs.
- Philanthropy: Charitable trusts allow individuals to give to causes they are interested in and possibly lower their taxable income.
5. Advantages of Creating a Trust Fund
- Control Over Asset Distribution: A trust gives a great amount of control, enabling the grantor to determine precise conditions under which and how the beneficiaries will receive the assets, either in lump sums or in installments.
- Privacy: In contrast to a will, which becomes a matter of public record at death, a trust is a private agreement, and this can be used to protect the privacy of the grantor and beneficiaries.
- Avoiding Probate: Because trust assets are not subject to probate, they can be transferred to beneficiaries faster than assets in a will, without the need for court intervention.
- Protecting Beneficiaries: Trusts can protect assets for minor children, keep creditors from attaching trust assets, or shield beneficiaries from their own financial irresponsibility.
6. How Trust Funds Work
When a trust is established, the grantor divests himself of title to the assets and conveys them to the trustee, who acquires legal title to the assets. The trustee must manage the assets of the trust, make decisions in accordance with the trust instrument, and distribute income or principal to the beneficiaries as directed. The trustee must act in compliance with the terms of the trust and in the best interests of the beneficiaries.
7. Funding a Trust
A trust works only when it is funded, that is, assets are put into it. This could include the placing of:
- Cash or Securities: Funds, shares, bonds, or other liquid resources.
- Real Estate: Properties, land, or investment houses.
- Life Insurance: Life insurance policies can be deposited into a trust to make provision for a death benefit for the beneficiaries.
- Business Interests: Ownership interest in a business can be deposited into the trust.
8. Trustee’s Responsibilities
Trustees owe a fiduciary duty to deal with the trust in a responsible manner, including:
- Asset Management: Keeping the assets of the trust invested and managed so as to maintain their value.
- Record Keeping: Keeping proper records of the transactions of the trust and accounting for all assets.
- Distributing Assets: Distributing the assets timely to the beneficiaries as per the trust agreement.
- Tax Filings: Making sure the trust is in accordance with tax regulations, such as filing tax returns for the trust.
9. Selecting a Trustee
The trustee must be responsible, trustworthy, and able to handle assets. A trustee may be:
- An Individual: A family member or close friend who knows the grantor’s intentions and can make decisions based on that.
- A Corporate Trustee: A bank or trust company that deals with trust funds professionally and objectively.
- Co-Trustees: Occasionally, multiple trustees are designated to divide the responsibility, having a balance between personal experience and professional handling.
10. Tax Implications of a Trust Fund
Trust funds can have tax implications, including:
- Income Tax: Trusts have to file a tax return and can be taxed on income realized from the assets of the trust. Depending upon the nature of the trust, income can either be taxed at the trust level or flow through to the beneficiaries, who have to report it on their individual tax returns.
- Estate Tax: The assets in an irrevocable trust are typically removed from the grantor’s estate for estate tax purposes, which can help reduce the tax burden upon death.
- Gift Tax: Transferring assets into a trust may trigger gift tax if the assets exceed the annual gift tax exemption.
11. Common Misconceptions About Trust Funds
- Trust Funds Are Reserved for the Rich: Though trust funds may be understood to belong to the affluent, they can be created by anyone who desires to control the distribution of their assets or secure the economic well-being of their family.
- Trust Funds Are Reserved for After Death: Trusts need not wait until death, as they can be established to provide advantages during the grantor’s lifetime, such as avoiding taxes or asset safeguarding.
12. Conclusion
Trust funds are a useful estate planning resource that provide flexibility, control, and protection for both the grantor and the recipients. They may be used to accomplish a range of purposes, from taking care of loved ones to funding philanthropic endeavors, all while avoiding taxes and eschewing probate. Whether you want to manage assets for your beneficiaries or protect vulnerable beneficiaries, a trust fund can be an extremely useful solution. It is important to seek the advice of an attorney or financial planner to make sure that the trust is established based on your particular needs and objectives.