What is a Trust Fund and How Does It Work?
You’ve probably heard the term “Trust Fund Baby,” but what actually is a trust fund and when should you get one?
It’s one of the tools that the ultra-rich seem to use often, and one of the financial tools that keeps the wealth gap in place – so we went ahead and looked into it for you. After all, it’s not just for robber barons, family empires, and spoiled children.
While the legal fees to set up certain types of Trust Funds, which can seem prohibitive (hiring a lawyer to set it up can be a minimum of a few thousand dollars), they are a financial vehicle worth learning more about, and one that can also be utilized by middle class earners.
Trust Fund Definition
Essentially, a trust is designed to make sure your money continues to be useful after you pass away. And, you can put restrictions on when the money is dispersed, and to whom. It can ensure your family’s legacy continues on in the way you’d like it to. You can decide when and how often your beneficiaries receive a payments, and can restrict the use of payments (e.g. you can say that it can only be used for education, medical or expenses, or to buy a first home).
A trust fund can consist of different types of assets such as stocks, bonds, cash, or property.
The anecdote most often associated with trust funds is a wealthy parent or grandparent, seeks to leave their heirs an amount of assets – but will say that the funds will only be used to pay for college.
There are multiple types of trust funds, a number of parties involved, and a whole spectrum of complexity and sophistication regarding the levers that may be attached to a Trust Fund.
Types Of Trust Funds
There are a myriad of types of trust funds, but the most common is a “living trust” also referred to as “inter vivos” trusts. This means the person who formed the trust was alive while it was created.
Of “living trusts”, there are two main types, Revocable and Irrevocable.
Revocable Trusts can be amended or cancelled at any point, but are taxed substantially and offer no protection if the “grantor” (person whose money is being disbursed) is for any reason being sued. As individuals do their estate planning, it may seem curious to choose a “Revocable Trust”, but a benefit of this is upon their passing the trustees, properties, bills, and other financial information will remain completely private. This is set against a “Will”, which though commonly utilized, becomes available to the public merely by going to the local court house and requesting it, as soon as the individual dies.
Irrevocable Trusts cannot be amended or revoked, and this finality can seem scary. However, once an asset is placed in an Irrevocable Trust they are no longer part of that person’s estate. This means they don’t have to pay income tax on what is made from the assets, can drop into a lower tax bracket as the assets are removed from their calculation of net worth, and depending on the creativity of the lawyer, won’t have to pay gift or estate taxes.
Though legal costs can add up quickly when looking into creating a family trust, they aren’t just for the ultra-wealthy. There are options that have minimums as low as $25 and don’t count against the individual receiving the assets. One thing to note is that there are many tax advantages to establishing a trust, and we’ve heard stories of younger individuals being creative about saving on taxes by utilizing a trust fund for their homes and other assets.
If you have a financial planner or advisor, we recommend talking to them about it, and see what works for you and your family. If you want to create generational wealth for your family, it’s worth looking into as a financial goal.