What is a trust fund? How does a trust fund work?

Brett Holzhauer
Brett Holzhauer August 24, 2023
what is a trust fund

A trust fund is a legal entity that is used to manage and hold assets or property to benefit another person or entity. It can be used in estate planning to determine how assets will be managed and passed. 

A trust can also be established as a part of your retirement plan to benefit you after you retire. There are many different types of trusts, and they are usually comprised of a grantor, trustee, and a designated beneficiary. 

The types of trusts that can be established in an estate plan may vary from state to state. You can use a trust fund in your estate plan to make certain that your wishes are followed after you die. Other benefits of setting up a trust could potentially include the following: 

Understanding the components of a trust 

A trust is made up of a grantor, trustee, and the beneficiaries. The grantor is the person who creates the trust. A trustee is a person or entity that is appointed to manage the trust assets and to hold the title to them. The beneficiaries are the people or entities that stand to benefit from the trust because they are specifically named or have met some eligibility requirements.  

The assets that may be held by a trust can include the following: 

  • Cash 
  • Stocks 
  • Mutual funds 
  • Bonds 
  • Real estate 
  • Other valuable property 

You can open a trust with M1 today, beginning your family’s journey to building wealth and preserving your hard-earned assets.

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The terms of a trust determine how the assets that are held by the trust will be invested, managed, or distributed. Some states have requirements for guardian appointments to administer the funds in a trust fund for child beneficiaries. 

Types of trust funds 

There are two main categories of trusts, but there are many different types of trusts that fall into the broader categories. One of the main types of trusts is a revocable trust. These are trusts that are created during the lifetime of the grantors in which the grantors retain the right to modify or add to the terms at any time. 

If you include all of your assets in a revocable trust, it may not have to go through the probate process. However, creditors can still reach the assets while you are still alive, and revocable trusts do not provide you with any tax benefits. 

The second broad category of trusts is irrevocable trusts. These are trusts that can be created during the grantor’s lifetime or after they pass away. Irrevocable trusts take ownership of the assets that are held by them in order to benefit the beneficiaries. An irrevocable trust may be a living or testamentary trust. 

Since the grantors no longer have ownership or control over the assets, irrevocable trusts are safe from legal judgments through lawsuits against the grantors. The grantors also will not typically have any tax liability for income that is generated by the assets in the trusts. However, grantors of irrevocable trusts cannot change or modify the terms unless they have secured the agreement of all of the beneficiaries. 

Living trusts are trusts that are created and funded by the grantor during their life. Testamentary trusts are irrevocable. These trusts are created after their creators die through the terms of the creators’ wills. The creators can change or cancel testamentary trusts while they are still alive by making changes to their wills. 

Setting up a trust for child beneficiaries: Types of trusts 

During the estate planning process, if you decide that you want to set up a trust fund for the benefit of a child, there are several different types of trusts that you should know about. The following types of trusts can be set up for children: 

  • 2503(b) trust 
  • 2503(c) trust 
  • Asset protection trust 
  • Crummey trust 
  • Family trust 
  • IRA trust 
  • Spendthrift trust 
  • Special needs trust 
  • Irrevocable life insurance trust or ILIT 
  • Pot trust 
  • Totten trust 

A 2503(b) trust is a trust fund in which there are annual distributions of income to a child while he or she is still a minor. The money is placed into a custodial account, or the child can be allowed to withdraw at least up to the amount of the yearly gift tax exclusion. This type of trust can be extended past when the child reaches age 21. 

A 2503(c) trust is also known as a minor’s trust. It is irrevocable, and all of the income and principal are used to benefit the child until he or she reaches age 21. After the child reaches age 21, the assets that remain in the trust must be distributed to the child unless he or she decides to extend it. Contributions to a 2503(c) trust qualify under the yearly gift tax exclusion. They are also exempt from the tax on generation-skipping transfers. 

An asset protection trust lets you secure your assets from the reach of creditors. You will still be able to maintain a degree of control over the assets in the trust. Some states allow you to establish an asset protection trust despite the fact that you do not live in the state. If you establish this type of trust in a state that does not have a state income tax, you can also enjoy some savings on your taxes. 

A Crummey trust lets you place restrictions on the ability of the assets will be able to access them. This type of trust lets you transfer assets while restricting when the beneficiaries are able to receive the money. Setting up a Crummey trust also lets you benefit from the gift tax exclusion. When parents are setting up a trust for child beneficiaries, this trust might be used to make lifetime gifts to them. 

Some people who set up a trust fund want to create something that will benefit their families. A family trust can be established to give a trustee the right to hold the legal title to the assets of the family to benefit one or more beneficiaries. This can help you to make certain that your wishes regarding the distribution of your assets will be followed and that any inheritance or estate taxes might be avoided or minimized. 

An IRA trust is a revocable trust that is designated as the beneficiary of your IRAs for after you die. The IRA trust will receive and hold the funds from your IRA account to benefit your beneficiaries. You can create different sub-accounts within the agreement that specify the beneficiaries and their terms. Note that you can also specify a beneficiary of your brokerage accounts that could allow your account to pass outside of probate, without having to put it in a trust fund. 

A spendthrift trust offers you a way to protect a loved one who has problems with managing money. He or she will not receive a lump-sum payment of the assets in the spendthrift trust. Instead, distributions will be made based on his or her needs. 

A special type of trust fund for child beneficiaries is a special needs trust. This can be established to make certain that children who have special needs will be cared for after you pass away. You can include provisions in the trust document that help to keep other family members from taking the assets away from the trust. 

Irrevocable life insurance trusts or ILITs are trusts that are named as the beneficiaries of their creators’ life insurance policies. If you set up one, your life insurance policy proceeds will be paid into the trust after you die. The trustee will manage the life insurance proceeds for the trust beneficiaries. An ILIT can help you to avoid having to pay estate taxes on the proceeds of your life insurance policies. 

Another type of trust that you might create during your estate planning process is called a family pot trust. In this type of trust, the trustee will have discretion over how the money should be spent on each of the child beneficiaries based on their individual needs. In estate plans, this type of trust is used when there are multiple child beneficiaries. 

Totten trusts are established in order to allow you to place money into an account or a security. When you die, the money that is held in the account or the security will be transferred to the beneficiaries that you have named. 

Disclaimer: This is not an exhaustive list of the types of trusts that you can create during the estate planning process. You should seek the assistance of a professional to learn more about the types of trusts that might be beneficial to your family.  

Benefits of a trust fund 

There are several benefits and limitations in creating a living or testamentary trust during the estate planning process. The potential benefits of establishing a trust include the ability to help protect your assets and assist your loved ones to avoid the probate process. 

If you do not take steps to avoid probate, your estate will go through a process which involves the court distributing your assets according to the terms of your will. If you die intestate, the court will decide how to distribute your assets under the state’s intestacy laws. 

The probate process can take many months or years to finish. The time frame will be longer if your estate is complex or if beneficiaries contest your will. The contents of a will become a matter of public record when it is probated. Before the distribution of your assets, fees will be deducted from your estate. The probate process can cost hundreds or thousands of dollars in legal fees and court costs. 

If you have children who are financially unstable or inexperienced, establishing a trust to benefit them can help. You can decide how your children will receive your assets, and the specifics will be kept private. A trust can be customized to fit your individual circumstances, and you can place restrictions on how your assets will be distributed. Finally, depending on the type of trust, a trust fund can potentially help you to protect your assets from creditors. 

There are also limitations of trusts. If you set up a trust, there will be expenses that must be paid to maintain it in addition to the costs involved with setting it up. If your estate is complex, you can expect the legal fees to be higher. The trustee will charge maintenance fees to manage your trust, which could come out of the trust assets. If claims are filed against the trust, you may have unexpected costs because of legal fees. Finally, the laws are in a constant state of flux. This means that you will have to review your trust document and to revise it as the laws change to keep it current and valid. 

Termination of a trust

A trust will terminate based on the instructions in the trust terms, usually when all beneficiaries reach a specific age or milestone. In that case, the trustee will then distribute any principal that remains together with the net income that has accumulated to the beneficiary, according to the terms. A trust can also terminate upon the beneficiary’s death. When this happens, the net income and principal of the trust will typically pass under the beneficiary’s will to his or her heirs (or based on the intestacy laws of the beneficiary’s state).

Setting up a trust fund can help you to ensure that your wishes are followed and that your children and family members are protected. M1 offers trust accounts to help manage your trust assets, and supports revocable and irrevocable trusts that invest in securities.

Open a customized M1 account today 

When you open an M1 account, you can pick the securities that will best match your risk tolerance level. If you are unsure of which investments you should choose, you can opt for a portfolio that has already been created to match different risk tolerances, goals, and investment durations. 

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