Understanding Trust Funds And Investments: A Beginner's Guide

Trust funds are a valuable tool for estate planning and can be used by anyone, regardless of their financial situation. They are legal arrangements that allow individuals to place assets in a special account to benefit another person or entity. While they can be complex to set up, often requiring the assistance of an attorney, they offer financial protections, tax benefits, and long-term support to loved ones. This article will provide an overview of trust funds, including their benefits, downsides, and the steps involved in setting one up.

Understanding the purpose of a trust fund

A trust fund is a legal entity designed to hold and manage assets on behalf of a person or organisation, usually with the help of a neutral third party. Trust funds are a tool for estate planning, allowing individuals to set aside money and other assets for loved ones or charitable causes.

The purpose of a trust fund is to ensure that assets are protected, distributed according to the grantor's wishes, and transferred smoothly. Trust funds also allow grantors to maintain control over their assets, designating who receives them and when. This can be during the grantor's lifetime, or after their death. For example, a grantor may wish to provide for a family member's education or help with the purchase of a first home.

Trust funds can be revocable or irrevocable. Revocable trusts allow the grantor to retain ownership and control of the assets, and can be changed or dissolved at any time. Irrevocable trusts, on the other hand, are very difficult or impossible to change or dissolve and require the unanimous consent of all beneficiaries. Irrevocable trusts offer greater protection from creditors and can reduce or eliminate estate taxes.

Trust funds can include a wide range of assets, such as money, real estate, stocks, bonds, artwork, vehicles, business interests, and more. The specific purpose of a trust fund will depend on the grantor's wishes and the type of trust established.

How to fund a trust fund

To fund a trust, you need to transfer ownership of your assets into the trust so that they can be managed and distributed as outlined in your estate plan. Here is a step-by-step guide on how to do this:

• Create a Trust-Based Estate Plan: Choose the type of trust that suits your needs (e.g. revocable or irrevocable) and legally document it with an attorney.
• Inventory Your Assets: Make a list of all your assets, including real estate, bank accounts, retirement funds, investments, and personal belongings.
• Gather Documentation: Collect the necessary documents for each asset, such as deeds, account statements, stock certificates, and vehicle titles.
• Open a Trust Account: For liquid assets, open a bank account in the name of your trust to hold funds or manage financial assets.
• Transfer Ownership of Assets: Update deeds, retitle accounts, and draft documents to transfer ownership of each asset to the trust.

The process of transferring assets into a trust can vary depending on the type of asset. For example, transferring real estate may involve signing a deed, while transferring a bank account may require contacting your financial institution. It's important to follow the appropriate steps for each type of asset to ensure a smooth transfer.

Additionally, keep in mind that your trust is designed to be a "Grantor Trust" for tax purposes. This means that assets held in the trust are treated as if they are still owned by the trust creator, with no difference in income tax reporting. The trust uses the social security number of the trust creator as the Taxpayer Identification Number (TIN).

The role of a trustee

A trustee is a person or firm that holds and administers property or assets for the benefit of a third party. Trustees have a fiduciary responsibility to the trust's beneficiary or beneficiaries, meaning they must act in the best interests of the beneficiaries to manage their assets. Trustees are usually designated by the original owner of the assets, called the trustor, but they can also be assigned by a court.

There are three types of trustees: individual (friends or family members), independent (businesses that specialise in trust fund management), and institutional (large financial institutions).

• Acting as a fiduciary: Ensuring the trust is administered according to the grantor's wishes and in the best interest of the beneficiaries.
• Ensuring the safety of the assets: Accounting for the funds and assets within the trust, understanding who the beneficiaries are and what their rights are, and keeping trust assets separate from other assets.
• Administering the trust: Keeping records of all transactions and distributing assets as required.
• Filing reports: Reporting to state and federal regulators as required, and keeping the beneficiaries updated.
• Making decisions: Making decisions about the assets as circumstances change, always in alignment with the grantor's wishes.
• Investing: Investing, allocating, or adjusting assets as needed according to the wishes of the grantor.
• Communicating with beneficiaries: Initiating communication with the beneficiaries and ensuring they clearly understand the grantor's wishes for the trust.

When choosing a trustee, it is important to select someone who understands the trust being set up and their responsibilities. For example, if the trust includes growing assets, appoint someone who understands how to grow wealth.

The types of trust funds

Trust funds are either revocable or irrevocable. Within these two categories, there are several types of trust funds, each serving a specific purpose. Here is a detailed overview of some common types of trust funds:

Revocable Trusts

Also known as living trusts, these can be changed or revoked at any time by the grantor, provided they are mentally competent. Totten trusts are an example of revocable trusts and are often referred to as a "poor man's trust". They are typically created during the lifetime of the grantor and do not require a written document, making them a low-cost option.

Irrevocable Trusts

Irrevocable trusts are difficult, if not impossible, to change or dissolve and require the unanimous consent of all beneficiaries to do so. They offer greater protection from creditors and can be beneficial for those in litigious professions or for asset protection.

Testamentary Trusts

Testamentary trusts are created within a will and only take effect upon the grantor's death. They are not considered living trusts and will go through the probate process, resulting in a loss of privacy.

Special Needs Trusts

Special needs trusts are designed to provide financial support to a physically or mentally disabled beneficiary without jeopardising their eligibility for government benefits such as Supplemental Security Income (SSI) or Medicaid. There are three main types of special needs trusts, depending on the specific circumstances and needs of the beneficiary.

Asset Protection Trusts

Asset protection trusts are a way to safeguard assets from creditors, legal disputes, or judgments against an estate. They are typically irrevocable and can be costly to establish.

Charitable Trusts

Charitable trusts benefit a charitable organisation or the general public. There are two main types: charitable lead trusts (CLTs) and charitable remainder trusts (CRTs). CLTs provide income to a charity for a set period, after which the remaining assets go to a beneficiary. CRTs provide income to a beneficiary first, and then the remaining assets are distributed to a charity.

Generation-Skipping Trusts

Generation-skipping trusts are designed for grantors who wish to leave their assets to grandchildren or individuals at least 37½ years younger than themselves. This type of trust provides tax benefits by bypassing the prior generation, resulting in reduced estate taxes.

Qualified Terminable Interest Property Trusts (QTIP Trusts)

QTIP trusts are used by married couples to ensure that assets are distributed according to their wishes while optimising tax benefits. The surviving spouse is the sole beneficiary during their lifetime, and the assets are distributed to other beneficiaries upon the second spouse's death.

Credit Shelter Trusts

Credit shelter trusts, also known as AB trusts, are used by married couples to minimise estate taxes. Upon the first spouse's death, the trust splits into two parts: the survivor's trust (A Trust) and the bypass trust (B Trust). The B Trust becomes irrevocable, safeguarding the inheritance for the deceased spouse's children.

The benefits of a trust fund

A trust fund is a legal entity that holds property and assets and can provide financial, tax, and legal protections. Here are some benefits of a trust fund:

Probate Avoidance

Trust funds allow you to avoid the probate process, which is necessary for distributing a decedent's property when they leave a will. This means that trust funds offer a quicker and simpler way of distributing assets upon death, maintaining privacy, and keeping family financial matters outside of public view.

Tax Benefits

Trust funds can provide tax advantages, particularly with irrevocable trusts. Irrevocable trusts can reduce or eliminate estate taxes after the grantor's death and offer transfer tax benefits since assets are permanently removed from the grantor's taxable estate. Additionally, contributions to irrevocable trusts are subject to gift tax requirements, and assets placed in this type of trust may be sheltered from estate tax upon the grantor's death.

Customizable Parameters for Asset Use

Trust funds allow for customization in estate planning. You can include conditions such as age attainment or parameters on how the assets will be used. For example, you can specify that funds are to be used only for college tuition for grandchildren once they turn 18.

Revocable Trusts for Illness or Disability

Revocable trusts can be beneficial during the grantor's lifetime if they become ill or unable to manage their assets. In such cases, a trustee can make distributions, pay bills, and even file tax returns on the grantor's behalf.

Flexibility

Trust funds, especially revocable trusts, offer flexibility as the terms of the trust agreement can be changed at any time by executing an amendment. This adaptability allows you to make changes to your estate plans as life circumstances evolve.

Frequently asked questions