What is a Trust Fund, and Why Should I Care?

What is a trust fund? What do terms like ‘revocable trust’, ‘irrevocable trust’, ‘living trust’ and ‘revocable living trust’ mean? Find all your answers here.

The term “trust fund” has become a standard dialect, partly due to cultural nods to high-net-worth individuals who strategically use trusts to manage their wealth. Despite the word’s prolificity, there’s quite a bit of mystery surrounding trust funds, what they actually are, and who can use them

Who is involved in a trust fund?

There are three parties concerned in the execution of a trust fund. You will want to carefully consider the individuals or institutions who you assign each benefit and responsibility as you move through the estate planning process.

Grantor/Settlor: That’s you! You own property and want to bequeath it to someone else. The property you own may include bank accounts, stocks, bonds, real estate, fine art or even a business. If you own something of value, odds are it can be placed within a trust.

Trustee: The trustee is the person or institution that executes management of the trust. You may have a financial advisor or a financial institution taking care of your properties, in which case you’ll likely have to pay a management fee. However, it’s completely possible to manage your trust on your own, serving as your own trustee, which allows you to eliminate that cost. Your final decision on this matter should be individualized to your own confidence in handling financial matters and the complexity of your assets. While it’s always good to save money, sometimes it’s safer to pay someone to complete a task you don’t know how to handle on your own. You may also want to assign a successor trustee in the event your original trustee dies.

Beneficiary: This is the individual who will benefit economically from the trust. They don’t have to agree to this financial arrangement, and in some cases they don’t even have to be made aware that the trust fund exists. This person is often a family member or friend. You can set up a trust with multiple beneficiaries if you so choose. The assets in the trust have to be managed in a way that will give beneficiaries economic benefit. You get to lay out how everything will be managed as the settlor through the process of establishing the trust.

Types of Trust Funds

There are a variety of different types of trust funds that can be made, but a major differentiating element is whether it is a revocable trust or irrevocable trust. A revocable trust—also known as a “living trust”—tends to be flexible, allowing the settlor to dissolve the agreement at any time should circumstances change. Irrevocable trusts are another story. Once established, an irrevocable trust’s terms are largely set in stone and can only be changed in very limited circumstances.

What is an irrevocable trust?

Irrevocable trusts tend to be used for two main reasons: Tax planning and creditor protection. If structured correctly, the growth in value of assets transferred to an irrevocable trust, as well as life insurance proceeds on policies owned by the trust, can be exempt from estate tax.

Irrevocable trusts also can protect assets if a creditor comes after you as the grantor. In certain circumstances, those you owe money to wouldn’t be able to touch the assets held within your irrevocable trust.

The gains on any assets within an irrevocable trust will not count as taxable income. That is because once you establish an irrevocable trust, you cannot change it. The assets in the trust will go to the beneficiaries as assigned, and you cannot modify these terms after they have been set. Since you are not benefitting from the monetary gains, it doesn’t count as your income. Because you only have one shot to get this right, enlisting the help of a team of estate plan attorneys is highly recommended.

What is a revocable trust?

Revocable trusts, also known as living trusts or revocable living trusts, are more flexible than irrevocable trusts. You can change the terms and beneficiaries while you’re alive should your financial circumstances or relationships change.

Because they are so flexible, though, there’s not as much protection. As the grantor, you still have the ability to change the terms of the trust to benefit yourself financially while you’re still alive. That means creditors can come after the assets held within your revocable trust fund should you find yourself in debt. It also means that any gains the trust fund incurs over the year will be subject to income tax.

One major reason to open a revocable trust is to help avoid the probate process, which happens after you die. If you distribute your estate via a last will and testament, it will likely still need to go through probate, which could be public and searchable. Anyone could be able to look up what assets and debts you left behind and who they went to. Additionally, the time it takes to distribute your estate is also likely to take longer if all you left was a will.

If you had a living trust, though, the assets held within it will likely not have to go through the probate process, making distribution faster and smoother for your beneficiaries..

Fun fact: After you die, your revocable trust can become an irrevocable trust.

Next Steps

At the end of the day, the best way to determine whether or not your financial situation is right for setting up a trust is to work with an experienced financial advisor. Creating a trust can be a complex matter, and details can vary depending upon state law and the guidance of a trust attorney can be highly beneficial.

Take the right steps, and a trust fund can help to preserve your legacy while also creating a sound financial future for your beneficiaries.