What is a trust fund?

No one likes to think about life’s what-ifs, but having an estate plan could be an important part of managing your family’s finances. Legal agreements—like a trust—could help you organize how your assets are distributed and protect your loved ones from financial burdens. 

But what exactly is a trust and how do you start one?

Key takeaways

• A trust allows a third party—called a trustee—to manage assets in a trust fund on behalf of a beneficiary, which is the party who receives the assets.
• A trust agreement is a document that allows a trustor to describe how they want their assets managed. A trustor—also known as a settlor or grantor—is the party who opens the trust. 
• A trust typically falls into one of two categories: revocable or irrevocable.
• Unlike wills, trusts generally don’t have to go through the probate court process.

Trust funds aren’t just for ultra-wealthy families. You may be surprised to learn that you don’t need a certain amount of money to start one. Depending on your financial situation, a trust might actually give you more options for managing your assets and maintaining financial security. 

That’s because a trust allows you to decide how you wish your assets to be passed down to family members, loved ones or even charities. 

A trust is a type of fiduciary agreement, which is an agreement in which a neutral third party is responsible for acting in the best interest of another party. 

In this case, a trustor—the person who opens the trust—appoints a third-party trustee to manage the trust. A trustee takes legal ownership of the trust’s assets and is responsible for managing and distributing those assets. 

A trustor can work with an estate planning attorney or financial planner to open a trust and prepare a legal document that details how they want their assets managed. This document usually allows the trustor to grant a trustee the right to hold the title to their assets—like property, life insurance policies, cash and more. And trusts usually outline how and when the trustee can give the assets to the trust’s beneficiaries. 

Trusts are often created to provide protections for a trustor’s assets while they’re alive and after they’ve passed away. There are a variety of reasons a person might open one. Some use trusts to protect their wealth so it can be passed down to their loved ones. Others create a trust so they can donate their assets to charity. Trusts typically don’t go to probate court or appear in public records, so they could also give families some privacy and peace of mind while an estate is settled. 

During the estate planning process, the trustee determines how their property and assets will be distributed among their beneficiaries. And beneficiaries could include a spouse, children, friends, charities or others. A trust allows a trustor to decide when their beneficiaries will receive the assets and what they can do with them. 

The trustor can specify whether beneficiaries receive trust funds as a lump sum or if the assets will be distributed in increments over time. They may even place certain restrictions on how beneficiaries use the money. 

Those with children may use a trust to manage family finances in the event of a parent’s passing. For example, once a trustor’s child turns 18, a certain amount of funds could be released from the trust to pay for the child’s college tuition. And once they turn 21, additional funds could be used to cover living expenses. 

Trusts vs. wills

Both trusts and wills are used for estate planning purposes, but there are key differences between the two. ​​

A will is a legal document that details instructions for how a person wants their assets distributed once they’ve passed. It can also detail guardianship for minor children.

Wills typically designate an executor, who is the person responsible for carrying out the will. Sometimes a will’s executor may also be a beneficiary, and if a will names multiple beneficiaries, this could complicate matters. 

Legal differences

Unlike a trust, a will typically goes through probate court. The probate court process can vary by state, but it typically governs how a deceased person’s property and debt are handled. 

A probate judge usually supervises the execution of the will. And if the deceased had outstanding debts, the estate’s funds could be used to pay them. It’s important to know that settling an estate through probate court can be a long and expensive process. And probate court records are public. 

Since trusts appoint trustees to manage estates, they usually avoid the probate process. This can help protect the privacy of the trustor and their beneficiaries. Plus, settling an estate with a trust is often quicker than settling one with a will. Trusts can also go into effect while a trustor is alive, while a will is only active upon the person’s passing. 

If you have questions about whether a will or trust is right for you, you can reach out to a lawyer who specializes in estate planning. They can walk you through different scenarios based on your personal situation.

There are several different types of trusts, and two of the most common categories are revocable trusts and irrevocable trusts. 

Revocable trust

A revocable trust, also called a living trust, allows a trustor to place assets in a trust while they’re alive. They can also make changes to the trust during their lifetime. With this type of trust, an estate could completely avoid the probate process. 

Even though assets in a revocable trust are not protected from creditors or estate taxes, the trustor has the ability to terminate, revoke or alter the trust as they see fit.

Revocable trusts may be easier to set up than irrevocable trusts, and they protect privacy by avoiding probate court. However, a revocable trust could be subject to federal estate taxes. 

Irrevocable trust

An irrevocable trust can’t be changed once it’s created. The assets in an irrevocable trust typically aren’t considered part of the trustor’s estate, so they might not be subject to estate taxes when the trustor dies. 

An irrevocable trust might offer some protection from creditors, too. That’s because assets in an irrevocable trust become the property of the trust and are no longer the property of the trustor. 

There are different types of trusts, and the one a person chooses could depend on their goals and financial situation. Here are some common examples of trust funds and how they work.

Generation-skipping trust

A generation-skipping trust is a trust in which the trustor’s property or assets skip a generation and go to beneficiaries who are at least 37 ½ years younger than the trustor. But they can’t be the trustor’s spouse or ex-spouse. 

Unlike with other forms of trusts—which may include multiple generations—a trustor’s children are typically excluded from a generation-skipping trust. The most common beneficiaries of generation-skipping trusts are grandchildren. 

Charitable lead trust

A charitable lead trust is an irrevocable trust in which the trustor’s assets give financial support to a charity for a specific period of time. When the trust ends, any remaining assets could go to the trustor’s private beneficiaries.

Charitable remainder trust

A charitable remainder trust is an irrevocable trust in which a beneficiary receives income for a specific amount of time. When the trust ends, the remaining benefits would go to the charities outlined in the trust agreement.

Credit shelter trust

A credit shelter trust—also called a family trust—could help married couples offset some federal estate taxes. It’s often created after the death of the first spouse, and assets in the trust are usually held separately from the surviving spouse’s estate. This trust structure might allow the assets to pass tax free to beneficiaries following the death of the second spouse. 

Irrevocable life insurance trust

An irrevocable life insurance trust could be used to control term or permanent life insurance policies and minimize estate taxes. It’s also used to distribute policy proceeds after the policyholder’s passing. 

Special needs trust

A special needs trust allows a disabled or chronically ill beneficiary to receive trust funds without affecting their eligibility for programs like Medicaid and Social Security. These funds could be used to cover expenses that public programs don’t cover, such as dental care or caretaking costs. 

When it comes to estate planning, there are some potential benefits of having a trust. The type of trust created could determine the exact benefits, but here are some possible advantages to consider. 

Protect and preserve assets

Certain types of trusts could minimize federal estate taxes and help protect a trustor’s assets from creditors. A trust can specify how and when assets are distributed to beneficiaries. And this might help family members or loved ones with money management. 

Avoid probate court and protect privacy

Trusts are far less likely than wills to go through the probate court process. As such, trusts can avoid probate fees and estates can typically be settled faster. Because the management of trusts usually happens outside the probate process, the distribution of assets remains private. 

Taxes

Some trusts—like irrevocable trusts—could minimize the amount of federal estate taxes an estate owes. But it’s important to note that certain assets in a trust may generate capital gains and could be subject to taxes. Tax laws for trusts can be complex, so it’s best to consult a professional tax adviser or estate planning attorney to fully understand your tax obligations. 

While there are potential benefits to establishing a trust, there could also be drawbacks.

Complex process

Establishing a trust can be a complex process. That’s because a trust can require detailed record keeping of property records, life insurance policies, asset transfers and more. If the trust doesn’t include all the trustor’s assets, part of the estate could wind up in probate court. 

Costs

Simple estates could establish a trust online for a nominal fee. However, setting up a trust typically requires a lawyer or financial planning professional. A trustor may have to pay attorneys’ fees, which can vary based on the size and complexity of the estate. Also, trustees—whether they’re family members or financial professionals—could be entitled to payment for managing the trust. 

The process for starting a trust could depend on factors such as the assets you want to include or the beneficiaries you choose. But here are some common steps you might take to establish one.

Determine your goals

If you review your financial health, objectives and goals before starting a trust, it may be easier to determine the type of trust that might benefit you the most. Consider which assets you want included in the trust and who you want to name as your beneficiaries. 

Find an estate planning attorney 

A lawyer who specializes in trusts can help you select the one that’s right for your situation. It’s helpful to bring the list of assets and beneficiaries you’d like to include in the trust agreement to the estate planning meeting.

Create a trust document

You can work with your attorney to draft a trust agreement. This step is where you’ll specify how and when you’d like your assets distributed. Once the details are finalized, you may have to get the document notarized or your lawyer might need to file a deed of trust. You can consult your attorney about your state’s requirements. 

File your trust with the IRS

Once your trust agreement is finalized and the assets are placed in the trust, you’ll probably need to file the trust with the IRS. A financial planner or estate lawyer can help you understand the tax obligations for your trust. 

Estate planning can help you plan for your family’s financial future. There are different types of trusts, each with its own potential benefits and drawbacks. Depending on the size of your estate and your goals for your assets, it could be helpful to set up a trust.

If you’re thinking about starting a trust, you could reach out to an estate lawyer or a financial planner to discuss your options. And if you’re looking for more ways to prepare for the future, you could read about setting and reaching financial goals.