Trust Funds: What are they and who needs one?

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Many new investors wrongly assume that trusts are only for the wealthy.

While it is true that trusts are often associated with fabulously wealthy families or powerful, plutocrats, a trust fund makes a lot of sense to the average joe who just wants to leave a nice some of money to his nephew to help him buy a house or get an education.

In this article, we break down the basics of trust funds to answer the following questions

  • What exactly is a trust fund?
  • What is the structure of a trust fund?
  • Why consider using a trust fund?

So, What Exactly Is A Trust Fund?

A trust fund is a special type of legal entity.

The trust fund holds property for the benefit of another person, group, or organization.  There are many different types of trust funds and many different trust fund provisions. These different provisions can change how a trust fund works.

In general, all trust funds have three important parties-

  • The Grantor: This is the person who establishes the trust fund or donates the property – really anything of value – to the fund. It is the grantor who decides the terms upon which the fund must be managed.
  • The Beneficiary: This is the person for whom the trust fund was established. The intention of the fund is that the assets in the trust will be managed to benefit him or her, as per the specifics laid out by the grantor.
  • The Trustee: The trustee -a single individual, an institution or multiple trusted advisors – is responsible for overseeing that the trust fund maintains its duties as laid out in the trust documents and applicable law.

Trust Fund Structure

A trust fund is a fictional entity.  The trust fund owes its existence to the state legislature of the state in which the trust was formed.

There are advantages to having a trust formed in certain states depending on what it is the grantor is attempting to accomplish. It is therefore advisable to work with a qualified attorney when drafting trust documents.

There are so-called perpetual trusts, which can last forever that are available in some states. Other states forbid such entities. The fear is that the perpetual trust will create a so-called “landed gentry class” resulting in future generations inheriting large amounts of wealth that were not earned.

The so-called “spendthrift” clause is one of the most popular provisions inserted into trust funds. Simply put, with this clause a beneficiary cannot pledge the assets of the trusts, or dip into them, to satisfy debts. This clause is a way for parents to ensure their “irresponsible” children don't end up homeless or broke regardless of any terrible life decisions.

Why Consider Using a Trust Fund

In addition to the creditor protections that can be enjoyed, there are several reasons trust funds are so popular:

  • An independent third-party trustee trust fund can help alleviate family squabbles over assets
  • Tax advantages can make it possible to shield thousands, or even millions of dollars and benefit your favorite charity.
  • Trust funds can be used to maximize estate tax bypasses. This will provide more cash to future surviving generations
  • Educational trust funds can be created that are designed to pay educational expenses and then distribute any additional principal following graduation as start-up money
  • Trust funds can protect assets that you cherish from your beneficiaries. This would help protect a business being ruined by a beneficiary while still letting them get financial benefits from it.
  • Trust funds can be used to transfer large sums of money. For instance, you can establish a small trust that purchases a life insurance policy on the grantor.  Upon the grantor’s death, the insurance proceeds are distributed to the trust, thereby funding it.  This money is then used for investments that generate dividends, interest, and rents for a designated beneficiary

 

Summary of Trust Funds

While this article should help you understand the basics of a trust fund and why you would want to obtain one, you should seek out professional advice for your particular needs and situation.

Trust funds are an effective way to ensure your wealth is preserved for future generations.  They can provide tax shelters and insure your beloved assets are managed wisely after you pass away.

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