What Is a Trust Fund and How Does It Work? Definition and Overview

There are many ways to set up a financially secure future for your loved ones. Trust funds, for example, can be a strong way to set your children or grandchildren up for future financial success. Also, contrary to popular opinion, they aren’t necessarily just for the very wealthy. In fact, you can open a trust fund to ensure your loved ones manage and distribute your assets in a specific way, regardless of your net worth. For help with trust funds or any other estate planning issues, you may want to consider working with a financial advisor.

What Is a Trust Fund?

A trust fund is a legal entity that holds property or assets on behalf of another person, group, or organization. It is an estate planning tool that keeps your assets in a trust managed by a neutral third party or trustee. A trust fund can include money, property, stock, a business, or a combination of these. The trustee holds onto the trust fund until the time comes to pass the assets on to your chosen recipients.

Trust funds provide for more control and specificity than a will does. This is because when you die, your will becomes a public record and there’s not always a guarantee your wishes will be met. With a trust fund, only the trustees and the beneficiaries know the contents and conditions of the fund. Additionally, certain trust funds can protect your assets from legal action and provide tax benefits.

How Do Trust Funds Work?

There are three parties who take part in a trust fund: the grantor, the trustee and the beneficiary. The grantor is the person who establishes the trust fund and places his or her assets into the fund. The trustee is the person or institution who holds and manages the assets. Finally, your beneficiary is the person you choose to receive the fund’s contents.

To set up a trust fund, the grantor works with a lawyer to create the trust. You can also choose a financial advisor to work with to help you allocate your assets in the best way. The grantor names the trustee, often a family member or a financial institution. A grantor must also name the beneficiary like their children or grandchildren, a business partner, or a charity. The grantor and the lawyer also draw up the terms of the trust fund. The terms include which assets the grantor will include and how they want those assets to be distributed.

Trust funds differ from other estate planning tools. They enable the grantor to provide specifications for how and when the beneficiary will receive the trust’s assets. For example, as a grantor, you may choose to pay out funds annually to the beneficiary or as a lump sum once the beneficiary reaches a certain age. The grantor can even specify the funds go towards a significant expense like college tuition or a down payment on a house.

A common inclusion in a trust fund is a “spendthrift clause.” This prevents a beneficiary from using the trust fund’s assets to pay off their debts. So even if your grandson were to gamble away all his own money and incur a ton of debt, his creditors can’t touch his trust fund. That way, your grandson can still have some backup money to help him get back on his feet.

Revocable vs. Irrevocable Trust Funds

Trust funds can typically be either revocable or irrevocable, which impacts how they can be updated after their initial creation. Here is how each works.

Irrevocable Trust Funds

Irrevocable trust funds, once established, are unchangeable. As the grantor, you cannot rescind the trust nor change the terms or distribution. This rigidity comes with some benefits.

First, because the grantor no longer owns the assets, they don’t need to pay income tax on money made by these assets. Funds from an irrevocable trust no longer count as part of the grantor’s estate. Therefore, moving assets into an irrevocable trust can also help the grantor move into a lower tax bracket or avoid paying estate tax. Irrevocable trusts also protect funds from legal claims and debts against the grantor. This way, the beneficiary can still benefit from those assets in the event the grantor falls into debt or hardship.

Revocable Trust Funds

Revocable trust funds, on the other hand, are changeable at any time. These are also called living trusts. You can update them as needed by adding or removing assets and beneficiaries. You can even dissolve the fund which results in returning the assets to the grantor. This allows for more flexibility and control, as changes can be made until the grantor dies.

However, unlike an irrevocable fund, the funds within a revocable trust are still part of the grantor’s estate. This leaves them less protected if the grantor faces legal claims, medical bills, or other debts. In this case, the funds in the revocable trust aren’t protected.

What Are the Different Types of Trust Funds?

There are several different types of trust funds that you can choose from, in addition to just choosing between making the trust fund revocable or not. The right one will depend on the purpose of the trust fund, as each benefits a different type of person or entity. Below we cover some of the most frequently used types of trust funds.

Blind Trust Fund: When a blind trust is established, the beneficiary of the trust is not aware of who holds the power of attorney to make decisions for the trust, though that is typically the trustee. These trusts are typically used to create a layer of separation and to eliminate any potential conflict of interest.
Land Trust: This type of trust exists to manage real property. If land or physical property is being passed from one generation to the next, then a land trust fund could help facilitate that transfer and give the power of management to the trust itself.
Charitable Remainder Trust: A charitable remainder trust, also called a charitable annuity trust, allows you to pass on your assets to a specified charity instead of a relative. The assets within this kind of fund provide a fixed-percentage income for the beneficiary during the life of the trust. When you fund a charitable remainder trust, you can immediately benefit from charitable-contribution tax credits. Plus, you’re donating your assets toward a great cause.

Who Needs a Trust Fund?

You’ll find trust funds useful if you want to leave money, property or other assets to someone else and ensure their use in a specific or incontestable way. You can set up a trust to pay out assets at specific times, like annually, for specific events like at graduation, or at a certain age. If you want to make sure your wealth lasts longer, you can choose to have it paid out to your beneficiaries in installments rather than a lump sum. If you want to pay for your grandchildren’s education, you can have it paid out for their tuition only.

Trust funds also combat some of the issues you might face with a will. Unlike a will, trusts are not subject to probate, the legal process that verifies your will. Since the assets in the trust belong to the trust, not the grantor, there’s no need to transfer ownership of those assets upon the grantor’s death. Without probate, trusts also keep your estate dealings private.

Bottom Line

A trust fund is a solid estate planning tool for those who want more control over their assets than what a will can provide. Trusts allow the grantor (the person setting up the trust) to define its terms. This principally includes how and when you want the contents of the trust to go to your beneficiaries. Irrevocable trust funds also provide some tax benefits and protection of their assets from legal action.

Estate Planning Tips

Determining whether a trust fund is needed, or which type you want to create, can be a difficult decision, and you shouldn’t have to go about it alone. A financial advisor can help you determine the right step forward for your situation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have free introductory calls with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’re planning on leaving a large pool of funds to your family following your death, you’ll want to plan ahead for the estate tax.
Trust funds can be an integral part of people’s estate plans. However, you’ll likely need to do much more than that to ensure your family is taken care of after you’re gone. Check out our guide on estate planning vs. wills to learn more.