Trust funds are an important estate planning tool. They can protect your assets while you’re alive and help ensure you leave money to your children or other loved ones after you die.
You'll need to make sure you understand how to start a trust fund the right way if you want to take advantage of this tool, though. The good news is, setting up a trust doesn't have to be hard if you follow this simple guide.
What is a trust fund?
A trust fund is simply an independent legal entity you create that takes ownership of assets and ensures the money and property are used in a way that's beneficial to your loved ones. Many people first learn about them when looking into estate planning, as they are a commonly used tool for transferring assets to family members.
Trust funds are created by a grantor, who sets up the trust and transfers money or property into it. They are created for a beneficiary, which is an individual or group who will benefit from the property held within the trust. The trust, however, will be the legal owner of that property. The grantor who creates a trust will name a trustee who will have a legal obligation to effectively manage the trust property following the grantor's wishes.
There are many benefits of setting up a trust to protect your family's finances. You can use a trust to transfer assets outside of probate, which is the legal process by which money is typically transferred to beneficiaries. It can also help ensure you don't lose your money paying nursing home costs toward the end of your life.
You can also use a trust to make sure money is appropriately managed for children. This can be especially helpful when leaving money to younger kids and can also make sense if you have older beneficiaries who don't know how to invest money effectively.
The specific advantages you enjoy will depend on the type of trust you create, which is why it's so important to learn all you can about the process so you can make the right decisions.
How does a trust fund work?
Typically, a trust is created when a grantor decides that having a separate legal arrangement for managing property is essential. The grantor fills out the legal paperwork needed to establish the trust and names a trustee to manage trust assets and the beneficiaries who will receive those assets. The grantor then transfers legal ownership of money, property, or other assets to the trust.
The trustee is responsible for managing the trust assets responsibly and making distributions of assets to beneficiaries when appropriate and per the instructions of the grantor. For example, if a grantor created a trust to pay for college costs for his children, the trustee will distribute the money to cover tuition bills.
Trusts can sometimes be modified, but in other types, they are irrevocable and changes can't easily be made once they are created. A trustee who manages a trust after the grantor has passed is called a successor trustee.
In some cases, trusts will continue to operate indefinitely. The legal assets held within the trust will continue to be owned and managed by the trustee for the long term. In other situations, the trust may temporarily own assets before they are distributed following the grantor's instructions. For example, a trust may hold assets for a child until the child reaches the age of 25.
The grantor has a lot of control over the specific of their trust but must always follow the proper steps in creating and funding it to ensure it's legally valid.
Types of trust funds
Revocable trusts are often used to avoid probate. The grantor retains a lot of control over revocable trusts, in many cases, even serving as the initial trustee while they’re still alive. The trust can be changed as needed, and property can be moved in and out of it. If the grantor is alive, the trust is referred to as a revocable living trust.
Revocable trusts are simple and easy, but they don't provide as much protection for assets as other trusts do, because the trustee still has control over the assets. The assets thus remain available to creditors or to cover nursing home care.
Irrevocable trusts cannot be easily changed once created. Property can't just be removed from the trust, and the grantor must give up more control of the assets the trust owns to the trustee. Irrevocable trusts can provide stronger protection for assets.
For example, this type of trust can shield your assets in case the grantor needs nursing home care. Medicare and most insurance won't pay for this care, but Medicaid does. The catch is that Medicaid typically requires assets to be spent down first. But once an irrevocable trust is created, the grantor won't own or control the assets in the trust anymore.
As long as the trust was created at least five years before Medicaid is needed to pay for nursing care, assets held within it don't have to be spent and can be left for loved ones.
Asset protection trust
Asset protection trusts are specifically designed to protect assets in case of creditor claims. They may be established in foreign jurisdictions and will typically be irrevocable for a certain length of time. Once the trust is established and assets are transferred into it, they are out of the grantor's control and out of reach for those who might make a claim on them.
Typically, an asset protection trust will allow for the undistributed portion of trust assets to go back to the grantor once the trust has been terminated. The grantor can do this once there's no further threat of creditor claims.
These help reduce estate taxes and provide for a charitable organization. Charitable remainder trusts are a common type of charitable trust. They allow the grantor or beneficiaries to receive an income stream for a designated period, whereas the remainder of trust assets go to a charity at the end of the trust's term.
Special needs trusts
These are created to provide for disabled individuals receiving means-tested government benefits. For example, a person with disabilities might get Medicaid and Supplemental Security Income and could lose access to these benefits upon directly inheriting money. A special needs trust can be created to hold assets on behalf of that person. The trustee can use the trust assets to provide for the beneficiary in approved ways, without jeopardizing government benefits.
These are created when a grantor is worried about a beneficiary spending money irresponsibly. Money or assets are put into the trust, and a responsible trustee manages the funds and distributes them to beneficiaries. The trust assets remain beyond the reach of the beneficiary's creditors, can't be lost due to irresponsible spending, and aren't at risk of being lost if the beneficiary divorces.
Benefits of trust funds
Protection of assets
Assets held in certain types of trusts are beyond the reach of creditors and won't be lost to creditor claims or if you must pay for expensive nursing home care later in life.
More control over what happens to your money
If you want your money used for a specific purpose after you die, creating a trust fund ensures that happens.
The option to choose a trusted person to manage wealth
When you create a trust and transfer assets into it, you get to decide who manages the money. This can be helpful if you're worried about becoming incapacitated and want to name someone to manage your wealth for you if that happens, or if you don't trust your heirs to manage money wisely.
If you're leaving assets to benefit someone who can't manage the money or property, such as assets to care for a child with disabilities or help support a beloved pet, a trust fund gives you the control you need.
Probate avoidance and tax benefits
Assets held in a trust can pass outside of the probate process, which means heirs can inherit more quickly and the transfer of property and money can be kept private instead of becoming part of public record during the probate process. In some cases, you may also be able to reduce or avoid estate taxes with the IRS through the strategic use of a trust.
Continued access to government benefits
Trusts can be used to allow a person to inherit without losing access to means-tested government benefits such as Medicaid or Supplemental Security Income.
How to set up a trust fund
If you've decided that using this legal tool is a good option, you need to know how to start a trust fund. Just follow these steps to setting up a trust to get started.
Step 1. Decide on your goals
If your goal is to protect assets during your life, you'll create a different kind of trust than if your primary purpose is to avoid probate or provide for a disabled loved one or avoid estate tax. You'll need to think carefully about the purpose of the trust so you can create the right type.
Step 2. Choose the type of trust
Once you know what you hope to accomplish, you'll decide what kind of trust will allow you to succeed in your goals. This could include any of the different types mentioned above, including irrevocable and revocable trusts as well as charitable remainder trusts or special needs trusts.
Step 3. Choose your trustee and beneficiaries
You'll next need to decide who is going to benefit from your trust and who is going to manage it.
The trustee you select to manage it should be someone you can count on to act impeccably, to manage or invest the trust assets wisely, and to follow the terms of the trust in carrying out your wishes with regards to how trust assets are used for beneficiaries.
The beneficiaries, of course, will be the people you create the trust to provide for. This could be a spouse, children, business partner, charitable organization, or other person or entity of your choosing.
Step 4. Create the trust
You'll next need to complete the required paperwork to create the trust as a separate legal entity. There are specific state laws and guidelines for how a trust document must be written. It's often best to work with an attorney to prepare the documents, but there are also online tools that you can use to walk you through doing this process yourself.
Step 5. Fund the trust
Finally, you will need to transfer assets into the trust. The trust will take legal ownership of the assets, which will be used to provide for your chosen beneficiaries.
How to assign a trustee
Assigning a trustee is one of the most important parts of setting up a trust. Trustees have a fiduciary duty to manage trust assets in the best interests of current and future beneficiaries. They must prudently manage trust assets and use the assets following the trust agreement.
The trustee should be someone whom you trust to carry out your wishes. They should be financially responsible, as you'll want them to manage and invest trust assets wisely. They should also have sound judgment and be capable of managing the trust for as long as needed.
Be sure to consider how old and healthy they are likely to be for the duration of the time their services are needed. You should also think about how close the trustee is located to the property to be managed and the beneficiaries who will benefit from the trust's assets.
Choosing the wrong trustee could undermine the purpose of creating a trust. In some cases, you may want to name co-trustees who have joint power to manage trust assets if you feel that it would be better to have multiple people providing input or you worry about the ability of your chosen trustee to manage assets over the long term. Alternately, you could choose a trust company to manage your assets.
Alternatives to trust funds
Instead of a trust, you could use a last will and testament to transfer assets to loved ones. However, you will have less control over how the money is used, the assets won't be protected, and they may have to pass through the probate process.
Life insurance may be another option, though it will only provide a lump sum for your beneficiaries, which can’t be managed or distributed based on your wishes.
If your goal is to provide for a loved one's education, then a 529 account is another alternative to an education trust. Learning how 529 plans work is helpful in deciding which approach is best. A 529 must be used solely for educational purposes, whereas trusts can provide more flexibility in how the funds are used. However, 529 plans can provide tax advantages for contributions to a child's education and could be a better fit if you're confident the money will be used for qualifying educational expenditures.
How much money do you need to start a trust fund?
There's no set minimum amount needed to start a trust fund. However, it's generally worth starting one only if you have a reasonable amount of assets you want to protect, because it can take time and money to set one up.
How much does it cost to set up a trust fund?
The cost of setting up a trust fund can vary. If you do it yourself, it could be as little as $100 or so to get started. If you use an estate planning attorney, you can expect to spend several thousand dollars on legal fees to get your trust document created and your trust funded. Although a financial advisor can’t give you legal advice, they may be able to help you decide if a trust makes sense for you.
Trust funds are a great tool to provide for loved ones, take control over how your money and property is used, and to protect your assets. But you need to use the right kind of trust fund and make sure you properly complete each step in the process to reap the benefits they offer.
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