What is a trust fund & who needs one?

You don't have to be a trust fund baby to benefit from this estate planning tool

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Elissa SuhSenior Editor & Disability Insurance ExpertElissa Suh is a disability insurance expert and a former senior editor at Policygenius, where she also covered wills, trusts, and advance planning. Her work has appeared in MarketWatch, CNBC, PBS, Inverse, The Philadelphia Inquirer, and more.

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Most people associate trust funds with wealthy families who have an abundance of wealth and property, but you don't actually need to own a lot of assets to benefit from a trust fund. Even if you have just a few, a trust fund can be an important part of your estate plan, whether you want to leave a legacy or simply have some control over your family's future finances to ensure that they are comfortable.

Key takeaways

  • A trust fund is simply a trust, which is a legal entity that manages a trust beneficiary’s money or assets.

  • Some types of trust funds can help protect assets from creditors and lower your taxes.

  • You can set up a trust fund while you're still alive as a way to distribute money to people right now.

What is the purpose of a trust fund?

A trust fund allows the person who created the trust (the grantor) to manage money and assets for the benefit of another person, the trust beneficiary. Many people create trust funds to disburse assets or give money to their family members and heirs over the course of their lifetime — which is why a beneficiary of a trust is sometimes maligned as a “trust fund baby.” 

A strong estate plan starts with life insurance

Trust vs trust funds

A trust fund is generally synonymous with a trust. All trusts are funded — assets (money, real estate, and more) need to be transferred into the trust in order for it to work. The only slight difference is that a trust fund may not pay out all the money and assets at once.

How does a trust fund work?

With a trust fund, the grantor (settlor) creates a trust agreement that outlines who their beneficiaries are and under what conditions they get assets in the trust. You can be as specific as you want about when the beneficiary receives the trust property (like immediately after you set it up or only after you die) and how they use it — like restricting trust funds for educational expenses. (For very specific restrictions like this one, you might need to consult with an estate planning attorney for legal advice to help ensure the trust successfully operates how you want.)

You don’t need millions of dollars for a trust fund to work, and establishing one for your child doesn’t automatically make them a “trust fund baby; a trust fund is a secure way to distribute incremental amounts of money to someone, even if you’re not wealthy.

→ Check out this guide on how to set up a trust, which is virtually the same way to set up a trust fund

After you establish a trust fund, your trustee will manage it. The trustee has a fiduciary duty to act according to your terms (a trustee can’t just withdraw money for their own sake), and when the trustee passes away, a successor trustee will take over after their death.

When you create a trust fund while you're still alive, it’s considered a living trust or inter vivos trust, and a trust fund that's created after you die, through instructions in your will, is a testamentary trust.

Funding the trust

You can fund a trust with bank accounts by renaming an existing bank account into the name of the trust, though some financial institutions may ask you to open a new account for the trust and then transfer funds into it. Similarly you can have the fund the trust with investments by opening a new brokerage account for it or transferring an existing account into the trust’s name. You can also transfer stocks and bonds into the trust fund by having them reissued. If you have investing goals for your trust fund, you may want to work with a financial advisor.

You can also transfer real estate to the trust fund, whether it's an income-generating property or just your primary residence that you won't to pass along when you die.

→ Learn about whether you should put your house in a trust

Trust fund taxes

Trust funds can offer some tax benefits for the grantor or the beneficiary, depending on what type of trust it is (revocable vs irrevocable). Generally the person who receives the trust funds has to pay income tax on the money they receive, but this may vary depending on whether the grantor is alive or if they have control over the trust. Additionally, the trust fund itself may have to pay taxes on the earnings. A financial advisor or tax accountant can tell you more about your situation.

To minimize estate tax and income tax, you generally need an irrevocable trust fund, which requires the help of an estate attorney to set up. They can help you better understand and follow the IRS guidelines so that your irrevocable trust fund performs as desired.

→ Learn more about when you have to pay trust taxes

Benefits of a trust fund

The main advantage of establishing a trust fund is having greater control over the beneficiary’s access to trust assets. 

Provide your beneficiary with a stream of income

You can ensure that your child’s inheritance is not squandered, by dividing it up over time instead of giving it to them as a lump sum. Trust funds are also useful for holding assets for beneficiaries who are minor children that can’t legally own assets yet.

→ Learn more about how trust assets are distributed to beneficiaries

Manage a beneficiary’s spending

With a trust fund you can make rules and set stipulations as to how the money can be used. You might have the trust pay out periodically, like once a month or on certain milestones, like birthdays. You might specify that trust funds should only be used for a house or a car or for college tuition. 

→ Learn more about spendthrift trusts

Get money to your beneficiaries faster

A trust fund also allows you to get assets to your beneficiaries more seamlessly than a will, which may need to be probated. The probate process can take a long time, especially for larger estates, but the assets in a trust fund will typically bypass court, since they are distributed separately by the trustee.

→ Learn more about how a trust avoids probate

Types of trust funds

When setting up the trust fund, you might also think about whether or not you want to be able to change it. Trusts that can be changed are revocable trusts and ones that can't are irrevocable trusts. (The trust created through Policygenius is a revocable living trust.) All trust funds fall into either category and the difference between these two types of trust funds is significant. A revocable trust fund won’t help the grantor avoid taxes or creditors, as we mentioned before, but an irrevocable trust fund will.

Special types of irrevocable trust funds usually have even greater benefits.

  • A charitable trust donates income to both a charitable organization and to beneficiaries and offers the grantor a tax break.

  • A special needs trust disburses money to a beneficiary with a disability and helps them qualify for government benefits.

  • A life insurance trust holds the proceeds of a life insurance policy.

  • A bypass trust can help reduce a surviving spouse’s tax burden and provide them with income.

→ Read more about different types of trusts

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