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Trust Fund: Definition, Types & Example

When it comes to estate planning, one of the most important decisions you will make is what to do with your money and assets after you die. One option for preserving your wealth is setting up a trust fund. But what is the trust fund definition, exactly? How does it work? And what are the benefits? In this article, we will answer your questions about trust funds!

What Is A Trust Fund?

A trust fund is a legal arrangement that allows a third party, known as a trustee, to manage assets on behalf of a beneficiary or multiple beneficiaries. Trust funds can be set up to protect and grow assets, minimize taxes, and provide funds for future generations. It is an essential tool in estate planning and can ensure that the beneficiary’s financial needs are taken care of. But why?

Trust funds are essential for estate planning because they provide a secure way to transfer assets to beneficiaries without the burden of probate. Trust funds also help to minimize taxes, protect assets from creditors, and provide financial security for future generations. Additionally, trust funds can be customized to meet the beneficiary’s specific needs, making them an ideal choice for those who want to ensure their money is used for the intended purpose.

How Does It Fund Work?

The main purpose of a trust is to preserve your wealth. When someone says they transferred assets to a trust, what they really mean is that they transferred “title” of the assets to the trustee, not full ownership. Therefore, the trustee holds the legal title of the asset for the benefit of the beneficiary. Still confused? It can be helpful to think of it like this…

There are three parties required to set up a trust fund:

  • The Trustee: person or company who holds the legal title of the assets for the benefit of the beneficiary, responsible for managing and administering the trust fund on behalf of the beneficiary.
  • The Grantor: person who sets up the trust fund and transfers the assets to the trustee, as well as determine what the trust will be used for.
  • The Beneficiary: an individual, charity, or any other organization designated by the grantor that receives benefits from the trust fund and does not need to be named in the trust agreement, since the trustee can change it at any time.

Now you know the three key roles. So, generally, when someone thinks about “ownership” of an asset, they are thinking of both legal ownership (ownership of title) and beneficial ownership (ability to do what you want with the asset and ability to benefit from it). These things combined equal ownership in its highest form, also known as fee simple ownership.

“Fee simple” is a legal phrase that barely anyone uses outside of law school, but it’s helpful here as an example. If you have fee simple ownership of a car you hold the title of the car (legal ownership), you can put flame decals on the car because it pleases you (ability to do what you want with the asset), and when you sell the car you can do whatever you want with the proceeds (ability to benefit from the asset). And with a trust fund, it works the same way!

The first step is for the trustor (the person setting up the trust) to transfer assets to the trustee. The trustor must also decide how the trust fund will be managed and how the assets will be distributed. The trustee must then manage the trust according to the trustor’s instructions. This includes investing in the support, monitoring the trust’s performance, and distributing funds according to the trustor’s instructions.

Types of Trust Funds Investments

Here are the three main types of trust you should consider before setting up a trust fund:

  1. Charitable Trusts: Charitable trusts are established to benefit a specific charity or organization and are typically used to fund research, educational programs, and other charitable activities. These trusts are funded by individuals, corporations, foundations, or other organizations. The funds are managed by a trustee and used to support the activities the trust is intended to fund.
  2. Special Needs Trusts: Special needs trusts are used to provide for the needs of a person with a disability, such as medical care, education, and other special needs. The trust is funded by the parents, family members, or other individuals and managed by a trustee who is responsible for overseeing the trust and ensuring that the funds are used for the beneficiary’s benefit.
  3. Testamentary Trusts: Testamentary trusts are created through a will and are intended to provide for the financial needs of the beneficiary after the death of the testator. The funds in the trust are managed by the trustee who is responsible for making sure the funds are used for the benefit of the beneficiary.
  4. Living Trusts: Living trusts are created while the grantor is still alive and are used to manage the grantor’s assets. The funds in the trust are managed by the trustee and are used to provide for the grantor’s needs during their lifetime.
  5. Irrevocable Trusts: Irrevocable trusts are created to protect assets from creditors and are typically used to preserve assets for future generations. The trust is managed by a trustee and the assets are not subject to the claims of the grantor’s creditors.
  6. Pooled Trusts: Pooled trusts are used to manage assets for multiple beneficiaries. The funds in the trust are managed by the trustee who is responsible for ensuring that the funds are used for the benefit of the beneficiaries. The funds are pooled together and managed by a professional investment manager.

There are tons of different variations of these. So we covered an extensive list of all types of trust in our trust 101 guide.

What are the Benefits of a Trust Fund?

  1. A trust fund can provide financial security for beneficiaries in times of need.
  2. Trust funds offer estate planning benefits, such as reducing or avoiding estate taxes.
  3. Trusts can be set up to provide for specific needs, like healthcare or education costs.
  4. Trusts offer privacy and asset protection benefits.
  5. Trustees have a fiduciary duty to manage trust assets prudently and in the best interests of the beneficiaries

The Disadvantages

  1. A trust fund can be expensive to set up and maintain.
  2. Trust funds offer little privacy – anyone who has the relevant information can see what assets are in the trust and who the beneficiaries are.
  3. The grantor (creator of the trust) maintains a high level of control over a trust fund, which some people may not want.
  4. Trustees have a fiduciary duty to manage trust assets in the best interests of the beneficiaries, which can be time-consuming and difficult at times.
  5. Trusts can be complicated legal documents that are difficult for non-lawyers to understand.

What is a Trust Fund Baby?

A trust fund baby is someone whose family saved up money or assets in a trust fund with the purpose of providing for him or her in the future. This money can be used for things like education, healthcare, or housing, among other investments. However, sometimes, the family will set up specific rules for the trust fund baby (or beneficiary), on how the money should be used for.

Next Steps

Trust funds are versatile agreements. You can structure them as you want, as long as it’s not illegal or a violation of public policy. This flexibility makes trusts a valuable tool with many different uses. Maybe for tax planning, asset protection, privacy reasons, or to replace wills. It’s up to your goals what type of trust you choose and how you do it.

Access more of our glossary terms to know more!

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