You may be wondering “What is a trust fund?” if you are looking to build wealth for younger family members. There is a common misconception that trust funds are only meant for the incredibly wealthy, so new investors sometimes shy away from them. However, trust accounts can be a sensible choice for smaller investments too. For example, a grandfather who wants to help fund his grandchild’s education can leave some money in trust to help pay for tuition, even if the amount does not cover all college expenses.
There are many useful ways that trust funds can be used to protect and preserve wealth for future generations. Many people are familiar with trusts but do not know how they work or do not think they can use them. Learn more about trusts and how they can help families from middle and wealthy classes preserve their assets for beneficiaries in the future.
What is a trust fund?
A trust fund is a unique type of account or legal entity that is used to hold onto assets meant for another person or organization. In general, trusts involve three primary parties: the grantor, the trustee and the beneficiary. Each of the following three parties plays a unique role in this financial relationship:
- Grantor – The person who establishes the family trusts by donating assets is known as the grantor. These donations can come in many forms, including stocks, bonds, real estate, art, mutual funds, cash, private businesses or any other asset that holds value. The grantor will also decide the terms of the trust accounts and how they will be managed.
- Trustee – The person, institution or advisors who are appointed to oversee and maintain the family trust fund according to the instructions of the grantor. Often, trustees will ask for a small management fee for their services. In some cases, the trustee may be responsible for managing the assets in the trust. Other times, the trustee may be required to choose investment advisors who will be in charge of handling the money.
- Beneficiary – This is the person who the family trust fund was started for. The beneficiary is the one who will receive all or part of the assets that are in the trust. However, the grantor can specify the rules and conditions under which the beneficiary is able to receive these assets.
Types of Trust Funds
In general, there are two main types of trust funds that a grantor can choose between. Each one has its own tax ramifications. A grantor can choose to create either:
- Revocable trusts – These types of family trusts allow grantors to maintain control over the assets they place in the trust. They will also be allowed to change beneficiaries and even retract the trust entirely. Grantors will also be given the option to name a successor trustee in case of an emergency. With a revocable trust, grantors still maintain ownership of all of their assets, and when they pass away, the assets will be subjected to estate taxes. If a grantor dies with debts, his or her assets may be used to pay off those debts.
- Irrevocable trusts – These trust funds are more permanent than revocable trusts and cannot be undone by the grantor. In fact, grantors are not able to make any changes to the terms or the future beneficiaries once they create these trusts. After assets are placed in an irrevocable trust, they no longer belong to the grantor. Assets in an irrevocable trust are not subjected to an estate tax after the grantor has passed away.
Benefits of a Trust Fund
There are numerous benefits to family trust funds that can make them an excellent financial option for many families even if they are not particularly wealthy. One of the most notable benefits of a trust is that the variety of options allows you to create an entity or account perfectly suited to your unique financial situation. Below are some common ways that establishing a trust can benefit you.
Revocable Trust Funds Give You Control Over Your Wealth
A properly established revocable family trust fund can help you ensure that your assets are available to help if you become incapacitated. After you have passed away, the trust can be used to manage who will receive assets in addition to the terms in which the distributions will occur.
This control of wealth is particularly beneficial for families with children from multiple marriages because it helps grantors ensure that their wishes for distributing the wealth are carried out.
Irrevocable Trust Funds Help to Reduce State Inheritance Taxes
In addition to federal estate taxes, numerous states and the District of Columbia are now imposing some form of inheritance or estate tax on family trusts. These taxes can take out a consequential amount of a grantor’s assets and significantly reduce the amount of benefits that beneficiaries will receive. A properly constructed irrevocable trust fund can help reduce state and federal estate taxes or generation-skipping transfer taxes.
Establishing Irrevocable Trust Funds for Gift Tax Considerations
Many families choose to establish trust accounts as a way to make a large outright gift in their lifetime. By doing so, these taxpayers can remove future appreciation from their estates by utilizing the elevated lifetime gift tax exclusions.
Grantors will need to establish irrevocable trust funds in order to take advantage of this option, which means they would be relinquishing control over the assets in the trust. Instead, they will have control over how and when the assets in the family trust funds will be distributed to beneficiaries.
The Bottom Line on Family Trust Funds
Setting up a family trust fund may be a good option for those who do not have a high net worth but would still like to leave money to their children or grandchildren. Trust funds allow for the grantor to control how that money is being used and when beneficiaries will be receiving the distributions. Trusts offer a valuable way for people to protect and distribute their assets long after they have passed away.