What is a Trust Fund?

Creating a trust fund is like hiring a babysitter…

You (the grantor) give your children (the beneficiaries) permission to stay in your house while you're away, but you don't fully trust them to use the home properly. So you hire a babysitter (the trustee) to watch over the home and kids while you're gone. The babysitter's job is to let the children do reasonable activities, like watching a movie, but refusing requests that aren't in their best interest, like throwing an all-night party.

A trust fund is a legal tool that lets someone set aside property, such as money or other assets, for another person's benefit (the beneficiary), without giving control of those assets to the recipient. Instead, the person establishing the trust (grantor) names a trustee, who manages the fund on the beneficiary’s behalf. In some cases, the grantor and the trustee can be the same person.

Trust funds are highly flexible in that they can hold almost any kind of asset, including stocks, bonds, or other securities. They can also hold real estate, property, a business, art, sculptures, or anything else of value. The division of control and ownership, as well as the variety of assets a trust can hold, make them useful tools for protecting and passing on money.

The point of a trust fund is to give money or assets to someone without giving them full control over those assets. Because that purpose is so broad, there are many potential reasons to establish a trust fund.

A common example is establishing a trust to provide for the care of a minor child. Parents might want to leave money to their children should they pass away, but they know that giving the funds directly to someone so young is a bad idea. Establishing a trust that lets a relative or other third party manage the money until the child comes of age ensures the child is provided for but doesn’t squander the inheritance.

Even when the beneficiaries are adults, grantors may worry about how their assets will be used. Spendthrift trusts allow someone to pass on assets but restrict beneficiaries’ access to them. This can prevent beneficiaries from spending the funds unwisely and protect the assets from his or her creditors.

Other common purposes for trust funds are philanthropy and avoiding taxes. Donors can create charitable trusts that let them earmark money for specific non-profits while reducing income, estate, and capital gains taxes. Funding a trust also allows you to take assets out of your estate, thereby passing wealth to heirs without estate taxes.

There are three essential players in making a trust fund work: the grantor, the trustee, and the beneficiary.

The grantor establishes and funds the trust. He or she must draw up the trust agreement and outline the terms. For example, the grantor may specify that the beneficiary will take control of half of the value of the trust at age 18 and the rest at age 30. Or the grantor may require that the funds only go toward college expenses.

The grantor names a trustee, who is responsible for managing the assets of the trust. In most scenarios, trustees, whether they’re a family member or a third party, have a fiduciary duty to the beneficiary. This means they have a legal requirement to act in the best interests of the beneficiary, not themselves. Grantors can also act as trustees of certain trusts.

Finally, the beneficiary is the one who benefits from the trust. Usually, this comes in the form of cash distributions. The terms of the trust may restrict how the beneficiary can access its assets.

There isn’t a fixed minimum amount required to start a trust. You may want to check whether the institution where you plan to open a trust has any requirements, but they’re likely to be low.

If you set up a trust yourself, it likely won’t cost you more than $100. If you work with an attorney, it could cost more than $1,000. Many banks and brokerages offer trustee services. There will likely be ongoing fees to maintain the trust, usually a percentage of the trust’s assets.

There are a few main types of trusts (some of which overlap):

• Living trust: This is typically established for the grantor's benefit. When the grantor dies, the assets in the trust pass to another named beneficiary. This type of trust is often used in estate planning to avoid probate, the legal process of verifying a will and distributing assets to heirs.
• Testamentary trust: This is laid out in an individual's will and established when he or she dies. This can be useful for someone who wants to pass money to an heir with conditions on its use and doesn’t want to make the gift during his or her lifetime.
• Revocable trust: The grantor can make changes to the trust at any time. He or she can add or remove funds, change the beneficiary or add another one, or name a new trustee.
• Irrevocable trust: This cannot be changed once established. Revocable trusts automatically become irrevocable when the grantor passes away. Assets given to irrevocable trusts are seen as no longer belonging to the grantor for tax and other purposes.
• Blind trust: Trustees have full control over the assets, and beneficiaries have no insight into its holdings. These are often created by wealthy people who become politicians to avoid conflicts of interest.
• Charitable trust: These are designed to let the grantor earmark funds for charity, either as a fixed amount annually or a percentage of the trust’s value. Medicaid trust: An irrevocable trust aims to help people avoid Medicaid asset limits.

The primary benefit of using trusts is that the grantor can give money to someone without giving that person control over the funds and place restrictions on how funds can be used.

Trusts give the grantor a way to exercise control over assets after giving them away or passing away. This arrangement makes it easier for people to make sure their wishes are followed. It can also provide tax or legal benefits.

For example, parents can use a trust to give money to a child while maintaining control over it, allowing them to use their annual gift tax exclusion (an amount you can give to someone without owing gift taxes) without incurring estate taxes. Putting money in a charitable trust allows someone to benefit charities of their choice while reducing income and estate taxes.

Trusts also help people bypass probate, the legal process of verifying a will, dealing with an estate’s creditors, and paying out assets to heirs. Money in a trust has already been legally given to the beneficiary. That means the funds are not part of the grantor's estate and probate process, so beneficiaries can access them sooner.

Trusts pay out in a variety of ways — It all depends on the terms set out in the trust documents. One trust may make monthly cash payments to the beneficiary. Another might provide large payouts on specific dates until the trust's funds are exhausted. A third could give the recipient specific sums when he or she reaches milestones, such as graduating from college or buying a house. It’s up to grantors to decide how the trust they establish should pay out.

Trust funds can collect interest if the assets they hold can generate interest. Trust funds can keep money in bank accounts, own a portfolio of stocks, bonds, or real estate, or hold anything else of value. Any returns, including interest that the trust's assets earn, belong to the trust.

While the popular image of a trust fund is something that millionaires give to their children, you don't have to be rich to start a trust fund — Anyone can do so.

The first step is figuring out your goals for the trust. You need to know why you're creating the trust, who the beneficiary is, and who you will name as trustee. You also need to know the restrictions you'll put on the use of the trust's funds.

Once you've decided on the specifics, you can draw up a trust document. Most people may want to hire a lawyer to help with this. After you put together the trust document, you and the trustee need to sign it to put it into effect. When the trust is up and running, you can transfer assets into the trust.

The process for starting a trust fund is the same whether you're rich or not, but if you don't have much to add to the trust, you'll want to make a plan to transfer assets at a later date. You might decide that you want to make regular contributions, or you may designate part of your estate to go to the trust in your will.