Trust Fund Basics: Everything You Need to Know - Werner Law Firm
Trust Fund Basics: Everything You Need to Know - Werner Law Firm

Trust Fund Basics: Everything You Need to Know

A trust fund is a trust dedicated to providing a wealth source for a beneficiary, usually for some time. Trust funds and trusts are generally interchangeable. The main difference is that a “trust fund” mostly describes an inheritance or estate planning tool meant to provide a source of income to a beneficiary over a period.

In contrast, trusts, in general, can be written to dissolve as quickly as possible, payout distributions over months and years, bequeath wealth only after certain conditions are met, and so on.  Primarily, the difference is mostly semantic. A trust fund is a trust, and trusts all share the same basic anatomy.

The Role of a Trust Fund in Estate Planning

A trust fund involves three separate parties, each with a crucial role to play. These are:

      1. The grantor: This is the person responsible for establishing and funding the trust with their assets and properties. These assets become the trust’s principal. In certain cases, grantors continue to manage and control the assets within the trust while they live.
      2. The trustee: A separate party is tasked with managing the trust. Trustees have a fiduciary duty to the beneficiaries of the trust and the grantor’s wishes.
      3. The beneficiary: Beneficiaries receive distributions from the trust, usually based on the trust’s income. These are taxable distributions. Trusts can also be used to transfer assets into a beneficiary’s ownership, effectively dissolving the trust.

Trusts are so flexible that one person can fill all three roles simultaneously, which can have distinct advantages. For estate planning purposes, however, the grantor, trustee, and beneficiary are usually separate people. The purpose of a trust fund is multifold and packed with several perks:

      • Tax benefits: Trusts are used over gifts to avoid gift taxes. Trust distributions based on the income of a trust are still taxed (either based on the trust’s own individual tax rate or the grantor’s income tax rate), but there are distinct tax advantages to distributing wealth through a trust fund, both before and after death.
      • Protection: Trusts protect the beneficiary from overspending or using their funds recklessly. Trust funds designed to give grandchildren or children a better start in life, for example, are designated towards tuition costs, managing the costs of inherited illnesses, or providing capital for a business once the beneficiary has finished their studies. They provide the grantor with much more control over how and when their contents should be distributed and for what purpose.
      • Ongoing transfers: The day-to-day management of a trust fund is handled by either the grantor or the trustee (and then just by the trustee, after the grantor’s death). The trustee can be an investment company, a bank, an attorney, or a friend. Generally, the trustee should be knowledgeable about the management of financial instruments. It is their fiduciary duty to adhere to the grantor’s wishes, manage the trust fund accordingly, and eventually distribute it. The trustee also bears a fiduciary responsibility towards the beneficiary. Every measure they take while managing trust increases the trust’s value and acts in the trustee’s best interests.
      • Intensions: Trusts provide a degree of protection from the public nature of the probate process. Anything not distributed after death through a trust or similar estate planning instrument must go through probate.

The Different Types of Trust Funds

Trust funds can be designed and set up in different ways. The most defining characteristic is whether a trust is revocable or irrevocable.

Revocable vs. Irrevocable Trusts

      • Revocable trusts are easily amended and usually include more control and involvement from the grantor.
      • Irrevocable trusts are, as the name implies, nigh impossible to amend. They can be changed or revoked through a process that requires each party’s consent. Still, these trusts are generally meant to be set in stone to gain more significant tax benefits due to being further separated from the grantor.

Purpose Trusts

      • Asset protection trusts are a form of irrevocable trust designed to protect assets from creditors and even insolvency. For debt and taxes, the grantor is locked out of the assets included in an asset protection trust, and it is a wholly separate entity.
      • Blind trusts are a form of a trust fund set up for oneself. These are usually created to avoid public concern regarding conflicts of interest, especially when an industry professional takes charge of a non-profit or charitable organization or enters politics. In a blind trust, the grantor funds any assets that may be a conflict of interest into a trust to be managed by an independent and neutral trustee, without any input or knowledge of how the trust will be managed.
      • Charitable trusts provide a dual purpose of distributing a cut to the beneficiary and distributing a fixed amount or percentage to a charitable organization (or multiple charities) each year, usually for tax purposes.
      • Other types of trusts exist, including ones designed to hold and manage land for investors, ones funded by life insurance policies or IRA remainders to reduce a grantor’s estate tax liabilities, trusts set up to finance the care of a special needs relative without leaving them ineligible for government benefits, and more.

The flexibility of trust is astounding, to the degree that you should always thoroughly review your options with an estate planning professional before drafting your first trust document. Your circumstances and finances may be best reflected by a hand-crafted, individualized trust fund rather than an archetypal template.

How Trusts Are Created in California

To get started, you must draft a trust document with a legal professional to fund and amend account details, deeds, and ownership to reflect their new status under the trust document. Simply creating a list of assets to add to the trust does not transfer them.

Funding the trust itself can be time-consuming yet is a critical step. The creation of the trust document outlines the purpose and function of the trust and those involved. Drafting this document with an experienced professional’s help is a must, as it might otherwise backfire. Trusts must be individualized to be effective.

While creating a trust itself is not very expensive (depending on who you go to for help), maintaining a trust does have its share of costs, especially to the trustee. Under the California Probate Code, these trustee fees are meant to be “reasonable,” but this definition is rather vague. Trustee compensation is usually negotiated between the grantor and trustee during the trust’s creation.

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