What is a Trust Fund? What You Need to Know About Trust Funds and Trusts

How Do Trusts Work

Anna Dunaeva DLegal Anna Dunaeva September 20, 2022
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What is a Trust Fund?

A trust fund means assets belonging to a trust. A trust is a legal entity that holds your money, real property, personal property, and other assets for the primary benefit of your designated recipients (aka beneficiaries of trust funds). Despite what some might think, trusts are not reserved for the ultra-wealthy. Every day people create trusts to protect assets, save on estate taxes, avoid probate court process, minimize gift taxes, preserve government benefits, and achieve other financial goals.

Trust Fund Meaning

The term trust funds refer to the trust’s assets. A grantor or settlor creates a trust to carry out their wishes, manage assets, simplify the probate process, or benefit the trust beneficiaries. When a settlor establishes a trust, they transfer assets to the trust to form their trust funds. Trust funds within a trust are managed by a trustee.

If you are unfamiliar with these terms, a settlor is a person who creates the trust and transfers assets to the trust fund. The beneficiary is who receives the assets. The trustee is someone responsible for protecting assets within a trust. Also, the trustee has the legal responsibility to look after the affairs of a trust. Only the trustees can make decisions regarding the trust funds.

A trustee can be a trusted friend or family member of the settlor, the settlor, or the beneficiary themselves, or a neutral third party, such as a financial institution, or a professional, such as an estate attorney, financial planner, or accountant. A trustee must maintain control and manage the trust property in the best interests of the trust beneficiaries and according to the wishes of the grantor. When the trustee has complete discretion over the trusts funds management, one can call it a blind trust.

Trust management requires skills and time, and trustees often receive compensation for their trouble and efforts. The trustee fees can be paid on an hourly basis, as a percentage of the value of the trust funds, or as a lump sum payment. Most of the time, the trustee compensation is stated by the settlor as one of the terms of the trust.

Trust funds can contain a wide range of assets including tangible personal property, money, securities, land or other real estate, proceeds of a life insurance policy, bank accounts, stocks, businesses, mutual funds accounts, an individual retirement account, and other investment types or assets.

Difference Between Wills and Trusts

Although trust is an important estate planning tool, it differs from a will. They both have their role in the estate planning process and outline what should be done with one’s valuables to honor their wishes, preserve property ownership, save on estate tax, avoid probate or ensure asset protection.

When it comes to a trust fund, property or assets are held in a trust with legally binding terms and conditions. A will is a legal document that outlines wishes regarding not only the distribution of goods after death but can also include more personal matters such as the care of a testator’s children.

The will always comes into effect only after an individual has passed away. However, a trust may begin to manage trust funds or distribute assets before the grantor’s death while the grantor (aka settlor) is still living. The will can not govern trust funds or supersede a trust if the latter is created separately from the will. However, one can make a trust within a will.

How Do Trusts Work?

Trusts are set up to manage and distribute trust funds. Each trust will have specific rules for how it should be managed. However, trusts come in many different forms, so there is not one catch-all rule for them all. When it comes time to set up a trust, your lawyer will be able to suggest the appropriate type of trust for you based on your net worth and interests.

Main Types of Trusts

The grantor has to make a few decisions when planning for a trust and creating a trust fund. First, will the trust exist during the grantor’s lifetime, or will it be established when the grantor dies? Who will manage the trust funds, what tax benefit one wants to achieve, and what is the purpose of the trust? Each type of trust has its pros and cons. The two main types of trust funds include testamentary trusts and living trusts. There can also be revocable trusts and irrevocable trusts. Also, one can distinguish trusts by type of trust funds, so there can be a land trust, an insurance trust, or an investment trust. Finally, trusts can be distinguished by their purpose. For example, one can create a charitable trust to benefit a specified charity, a spendthrift trust to provide maintenance for a family member who can’t manage finances adequately, or a trust to take care of a surviving spouse on the grantor’s death.

TESTAMENTARY TRUST

A testamentary trust creates irrevocable trust funds after a settlor’s death. The terms of the trust will be laid out in the testator’s last will and testament. This is a type of irrevocable trust because it does not warrant any changes or alterations. In this instance, the executor will often be responsible for setting up the trust and managing the irrevocable trust funds to the settlor’s wishes.

IRREVOCABLE TRUSTS

With an irrevocable trust, no changes can be made to the terms of the trust once the appropriate documents have been signed. All assets become the property of the irrevocable trust fund until they are ready to be managed or distributed.

REVOCABLE LIVING TRUSTS

These trusts are usually living trusts set up during the settlor’s life. In most cases of a revocable living trust, the settlor is also the beneficiary or the trustee. They can add, remove or update beneficiaries, assets within the revocable trust funds, trustee fees, or any other terms of the trust.

Then, the trust may continue for other beneficiaries after the settlor passes. A revocable trust does not go through the probate process, so there is no public record, and more privacy is involved. However, a marked disadvantage of a living trust is considerable taxes. Also, in some instances, the assets within the revocable living trust fund can be seized by creditors because they can be viewed as still belonging to the settlor.

CHARITABLE TRUST

A charitable trust is designed to benefit a specified charity. The two main types of charitable trusts are the charitable lead trust and the charitable remainder trust. The charitable lead trust is designed to manage trust funds for a particular charity. The charitable remainder trust means that a specified charity will benefit from trust funds only after the prior beneficiaries receive their shares. These types of trusts can provide tax benefits and deductions.

BLIND TRUST

With a blind trust, all control of the trust funds is transferred to an independent trust. This trustee is charged with controlling and managing the blind trust as they see fit in accordance with its terms. It is done this way to handle any real or perceived conflict. For example, your trustee can buy and sell assets such as stocks without the knowledge or consent of the beneficiaries or grantor.

INSURANCE TRUST

An insurance trust is usually a testamentary irrevocable trust that allows the grantor to add their life insurance policy to a trust. This can help escape estate tax and allows the beneficiaries to benefit from its after-life payout.

ASSET PROTECTION TRUST

An asset protection trust is a trust which is designed to protect assets from creditors. In many cases, this is to protect the financial legacy of the beneficiaries if something happens (such as a personal injury claim if you own a small business), which would require you to pay large financial sums.

SPENDTHRIFT TRUST

A spendthrift trust is designed to spread assets over a specified period. This is often used if the grantor is concerned the beneficiary might not be able to manage the assets responsively if given in a lump sum payment or if they want to save a payout for major life milestones. For example, a spendthrift trust is helpful for paying for college expenses or if the child has a disability or addiction.

LAND TRUST

A land trust is a living trust which gives control of a parcel of land to a legal entity. It is governed by its own unique set of rules. This type of trust fund can take many forms and can include conservation efforts at the behest of the grantor.

These are not the only types of trusts available. Other types of trusts include an employee trust, common-law partner trust, TFSA trust, and so much more. Again, your estate attorney will be able to aid you in choosing the right trust for your situation.

How to Set Up a Trust

People tend to shy away from setting up a trust mainly because of the legal fees involved. However, this one-time fee is small compared to the peace of mind it can give you and your beneficiaries.

Trusts are complex legal entities. If you want to begin preserving and distributing assets in a particular way, you might benefit from professional legal advice. To start setting up a trust, discuss your tax goals with a tax advisor to ensure you comply with the tax code requirements. Also, talk to a financial professional. They will analyze your financial situation and provide counsel on choosing the best trust fund for your goals. Once you know what kind of trust you want, find a law firm specializing in estate planning. They will assist with the legal process of establishing a trust for your goals and transferring the property into the trust fund. After all, trusts can be one of your most powerful estate planning tools. However, only if they are set up correctly.

Contact DLegal law office today to begin setting up a trust. We will guide you through the estate planning process to help you meet your personal financial planning goals. If you are still hesitant about a trust, consider other estate planning tools, such as wills to protect your family on death, a power of attorney and any guardianship plan to address proper management of your property, financial and personal matters in case of your mental infirmity.

Questions?

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