In social media, it is not uncommon to hear the term “trust fund kid,” which is associated with a spoiled child who has inherited their family’s wealth. The term generally comes with a negative connotation, but it is essential to understand that a trust fund is an extremely lucrative financial tool.
A trust fund is a significantly crucial estate planning tool. Establishing a trust fund helps an individual preserve their wealth, avoid having the state divide their assets upon death, reduce tax impact, and provide financial security for loved ones throughout generations.
How Does a Trust Fund Work?
A trust refers to a legally binding relationship in which one party, known as the trustor, gives another party, known as the trustee, the lawful right of property or assets which must be kept and used solely for the third party’s benefit, referred to as the “beneficiary.”
Simply put, a trust can be thought of as a “miniature business” that is used by the trustee to handle the trustor’s assets until they pass away. Upon the death of the trustor, the trustee who is responsible for the assets then allocates said assets to the beneficiaries based on the desires of the trustee, which are stated in the trust agreement.
Trusts operate incongruously based on the type of trust the trustor decides to establish. From a baseline level, trust can be classified into three separate categories, which are: living vs. testimonial, revocable vs. irrevocable, and funded vs. unfunded.
How to Establish a Trust Fund
Once the trustor has determined that they own a large amount of assets that they wish to be preserved, it is a lucrative idea to establish a trust.
During the beginning stages of setting up a trust, the individual would want to engage with a financial planner and an estate lawyer.
The financial advisor will be able to help the trustor determine the financial goals of the trust, where the wealth goes after the death of the trustor, and ensure the best financial decision is being made.
The estate lawyer will help with legality, outline rules and regulations, and generate the provisions of the trust, known as the trust agreement.
Within the trust agreement, the trustor will be responsible for outlining the trustee, the beneficiaries, and how/when the funds in the trust will be allocated.
Advantages of a Trust Fund
When deciding on whether or not to establish a trust fund, it is important to be aware of the advantages they bring forth. The advantages include:
Protection of assets
Control of asset distribution after death
Providing privacy for allocation after death
Reduction of tax consequences
Preserving of disability benefits
Establishing a trust fund is an increasingly important financial tool that individuals should use if they wish to preserve and control their wealth after they pass. Additionally, creating a trust fund ensures privacy and enables financial benefits such as tax exemptions.
Types of Trust Funds
Within trust law, a wide array of trust funds can be set up, which all bring forth different advantages and asset allocation.
We’ve included five common and five uncommon types of trust funds:
Living Trust: A living trust, or an “inter-vivos trust,” is a legal document in which the trustor’s assets are used as a trust and can benefit them during their lifetime. The responsibility for the assets is given to the trustee, which is then transferred to the eventual beneficiaries once the trustor passes away.
Testamentary Trust: A testamentary trust, or a “will trust,” is similar to a living trust except for the fact that the trust will only take effect after the death of the trustor, not during their lifetime.
Revocable Trust: A revocable trust is a trust that can be altered or terminated by the trustor during their lifetime.
Irrevocable Trust: An irrevocable trust is a trust that cannot be changed by the trustor once it is initially established. In some cases, a trust may become irrevocable after the trustor’s death.
Funded Trust: A funded trust is a specific classification of a trust where assets are consistently put into it by the trustor during their lifetime.
Employee Trust: A trust that is established for the benefits of the employees within an organization.
Hybrid Trust: A type of trust that combines elements of both fixed and discretionary trusts. In a hybrid trust, the trustee must contribute a certain amount of the trust property to each beneficiary fixed by the trustor.
Improvement Trust: A type of trust that is set up by the local government to hold funds for the improvement or development of an area within the municipality. These types of trusts are often run by the local committee.
Unit Trust: A type of trust where the beneficiates each possess a certain share (referred to as units) and can direct the trustees to pay them out of the property within the trust based on the amount of units they possess.
Personal Injury Trust: A personal injury trust is any form of trust where the funds are held by the trustees for the benefit of an individual who suffered a traumatic injury. The recovery process is funded exclusively by the funds derived from payments made in consequence of the traumatic injury.
In order to understand the national scope of trust funds, we’ve provided the most prominent trust funds that exist in the world today.
Thank you for reading CFI’s guide to Trust Funds. In order to help you become a world-class financial analyst and advance your career to your fullest potential, these additional resources will be very helpful: