Trust Funds: They're Not Just For The Wealthy (2024)

When you hear the word trust fund, you might think of the uber-wealthy giving their kids a big chunk of cash on their 25th birthday. But trust funds aren’t just for the rich. A trust fund is an estate planning tool that anyone can use to ensure their assets are passed down as they wish, to friends, family or a charity.

What Is a Trust Fund?

A trust fund is a legal entity that holds assets until an intended recipient is able to receive them. This may be when the recipient reaches a certain age or after the previous owner of the assets has died.

To understand how a trust fund works, it helps to understand the following three terms:

• Grantor. This is the person who transfers assets to a trust fund. That would be you, if you’re the one looking to start a trust.
• Beneficiary. The person who is given the legal right to assets in a trust fund is a beneficiary. That might be your loved ones or a favorite charity.
• Trustee. The decisionmaker responsible for ensuring the assets in the trust fund are appropriately distributed is called the trustee.

Trusts can hold assets like real property (such as heirlooms or jewelry), real estate, stocks, bonds or even businesses.

Assets like cars and life insurance shouldn’t be placed in a trust without first consulting a tax professional or estate attorney. Assets like retirement accounts shouldn’t be placed in a trust because they generally have a named beneficiary already, which keeps them outside of probate, the sometimes-long legal process of affirming a will and distributing assets the way it instructs.

Assets can be transferred into a trust fund in one of two ways. As a grantor, you can either transfer assets into a trust fund while you are alive, or use your estate plan to stipulate that a trust fund will be created and receive certain assets when you die.

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Reasons to Create a Trust Fund

Although the reasons for creating a trust fund are numerous, here are some of the most common reasons you might do so—as well as the types of trusts best suited to them.

• Avoiding probate. Assets held in a trust fund pass to beneficiaries outside of the probate process. For this purpose, you could establish a revocable living trust.
• Protecting beneficiaries. If a beneficiary doesn’t yet have the life skills necessary to manage the assets in the trust (like someone under 18 inheriting a substantial sum of cash), you can establish a contingent trust that releases assets to them only once they reach a certain age.
• Protecting assets. If you want to protect certain assets for your children if they someday experience divorce, you could set up a spendthrift trust to ensure that your child’s former spouse has no claim to the assets in the trust.
• Establishing a line of inheritance. If you want your surviving spouse to receive assets in the trust first and then pass the remaining assets to designated beneficiaries when they die, you could establish a spousal trust, also known as a bypass, credit shelter, family or A/B trust.
• Taxation. If you want to reduce your tax liability or avoid potential estate tax, you can transfer assets into an irrevocable trust. Since assets in this type of trust are no longer held by you, you won’t have to pay income taxes during your lifetime and those assets potentially avoid estate taxes when you die.
• Providing for a disabled beneficiary. Certain social services are limited to those with low net worths and incomes. If you want to ensure that a disabled person in your care can continue to receive government services when you die, even if they inherit money, you might set up a supplemental needs or special needs trust.

Most trust funds can also be grouped into two categories: revocable or irrevocable.

“Revocable trust funds allow the grantor to amend or revoke the trust over the grantor’s lifetime,” says Jay Knighton, a board-certified estate planning and probate attorney with Knighton Stone, PLLC. “Irrevocable trust funds are permanent and typically cannot be easily modified after creation.”

Benefits and Drawbacks of Trust Funds

Each type of trust fund comes with its own pros and cons. Here’s how those break down for the two main groups of trust funds: revocable and irrevocable trusts.

Benefits of Revocable Trust Funds

• Asset Management. Revocable trusts provide easy management and control of assets, “which can be very helpful for elderly individuals with children who live in other cities,” says Knighton. Since assets transferred to a trust must be titled in the trust’s name, the trust can streamline a wide array of assets under a single umbrella, and when the grantor dies, a trustee is able to maintain control of the assets.
• Avoiding Probate. If you live in a state where probate costs can be high and probate times lengthy, assets held in trust can easily pass to your heirs and help them avoid waiting on the state to settle your estate.
• Privacy. A revocable trust will allow you to remove your property ownership from public record. To keep things private, consider trust names that obscure personal information, like the JJS Revocable Trust instead of the John James Smith Revocable Trust, says Knighton.

Drawbacks of Revocable Trust Funds

• High costs. The costs to set up a revocable trust will vary by the complexity of your estate and the state you live in. Expect to pay legal fees, asset retitling fees, tax filing fees and trustee fees, among others.
• Extra complexity. Many people opt to create a revocable trust to avoid probate processes when they pass. But if they don’t stay on top of all new asset acquisitions, their heirs may still have to wade through probate. “One helpful tip is to ensure that your estate planning attorney follows up with you regularly to remind you that if you acquire new titled assets, be sure that the revocable trust holds that title,” says Knighton.
• Not a substitute for an estate plan. A trust doesn’t replace estate planning. Rather, it’s one part of a comprehensive estate plan and can also play a role in your tax strategy.
• Faith in your trustees. Just as with naming an executor in your will, naming a trustee isn’t a task to take lightly. You need to have an extremely high level of trust in the person you name as trustee to have peace of mind that they will ethically manage the assets in your trust and distribute them as you intend.

By and large, all of the advantages—and disadvantages—of revocable trusts carry over to their irrevocable counterparts, as well as a few additional pros and cons.

Benefits of Irrevocable Trust Funds

• Tax management. Often, people establish irrevocable trusts to subtract assets from their net worth and minimize potential estate taxes, Knighton says. What’s more, since assets are no longer titled in a person’s name, it’s possible they can reduce their tax liability while living.
• Responsible transfer of wealth. An irrevocable trust can be used as a tool to teach responsible asset management to children, Knighton says. For example, an irrevocable trust could stipulate that beneficiaries must meet certain conditions (like attending college or having a job) to receive benefits.
• Asset Protection. An irrevocable trust can shield your assets from litigation since the assets in your trust are no longer held in your name.

Drawbacks of Irrevocable Trust Funds

• Permanence. The biggest drawback to irrevocable trusts is the fact they’re permanent. Some state laws may allow for a small amount of modification after an asset is placed in an irrevocable trust, but you shouldn’t count on that. “Due to the permanency of the irrevocable trust, many grantors are reluctant to utilize it and take advantage of all its benefits,” Knighton says.

Do You Need a Trust Fund and a Will?

While trust funds can offer many benefits to those wanting to avoid probate and protect their assets, establishing one doesn’t necessarily eliminate the need for a will.

For instance, if you’re establishing an irrevocable trust, a will may not be necessary, says Knighton. However, if you’re setting up a revocable trust designed to avoid probate, you should also have a will. This will help address one of the primary disadvantages of a revocable trust—that you may hold certain assets that you fail to place into a trust before you die. Maybe you forgot about a checking account at a credit union or a stray certificate of deposit (CD).

That’s where a pour-over will comes in, says Knighton.

“The Pour-Over Will literally and figuratively ‘pours over’ any titled assets that the grantor perhaps forgot to retitle in the name of the revocable trust,’ says Knighton.

How to Set Up a Trust Fund

Contrary to popular perception, you don’t have to be wealthy to set up a trust fund.

“Net worth is a very small component when considering whether to establish a trust fund in the estate plan,” Knighton says. “The key determinants are your goals in your estate plan, then to understand if a trust fund will help accomplish those goals.”

If you decide through your estate planning that a trust fund would be beneficial, then you have two ways to set one up: a DIY approach or hiring an estate attorney.

“There’s no rule that requires you to have an attorney to set up a trust,” says Neel Shah, certified financial planner (CFP) at Beacon Wealth Solutions. “However, how do you know when you’re doing it wrong? You generally only find out if there’s a mistake or an error when it’s too late. If you’re confident you have the legal expertise, by all means, you can create a trust on your own.”

For those committed to a DIY approach, there are several online services such as LegalZoom, Nolo and RocketLawyer, that can help you craft legally binding documents using templates specific to your state of residence. But just because you can take the DIY path, should you?

“Trusts are highly customized documents designed to fit a grantor’s specific goals for their beneficiaries,” Knighton says. “It is next to impossible for an automated system to create a similar document that an estate planning attorney can design with an in-person meeting. Many automated services are designed in a one size fits all approach.”

Hire a Professional to Set Up Your Trust Fund

If you’re interested in setting up a trust fund as part of your estate plan, take advantage of the expertise of a professional who deals with trust funds on a daily basis, Knighton says. You can leverage your relationship with your financial advisor or tax professional during your annual review meeting to get a referral for a local estate planning attorney. An estate planning-specific attorney is crucial, rather than one who practices “door law” (whatever walks in the door, that attorney will try to tackle), says Knighton.

“Assembling a strong steam of advisors is crucial when initiating your estate plan to ensure proper coordination of all aspects of your assets, from beneficiary designations to account titles to ownership,” says Knighton. “You are the common thread that brings your team of advisors together during your lifetime. However, that team needs to work together during your lifetime to ensure a seamless transition for your titled assets.”