Corporate Finance Tutorials
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- Trust Account
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What is a Trust Account?
A trust is a financial account opened and managed by the trustee in order to overlook and manage the assets or funds of the beneficiary as per the legally binding arrangement. Creator of trust is known as settlor or grantor. Trust account is an important tool for estate planning.
- When a trust is created, party transfers all the legal ownership of the property to the third party (individual or group) who will be responsible for the proper handling of the property.
- This third party is known as the trustee and the party for whose benefit trustee manages the assets or funds is known as the beneficiary.
- The trust doesn’t have any of the powers with respect to the property until the beneficiary transfers the assets or the funds into a trust account. Generally, a bank or the other financial institution in existence acts as the custodian of the assets of the trust.
- These custodians place the assets in the trust account under the name of the trust. After that, all the distributions and expenses which are related to the beneficiary will be done from this account only.
Features of Trust Account
- “Funding the trust” is one of the most important features of the trust account. It is the process under which the funds or assets are transferred to trust. If the ownership of property is not transferred to trust, it has no power to manage the same.
- It is mandatory that the trustee is a mentally competent adult who has a responsibility of handling a trust account.
- A trustee has full authority with respect to making any type of changes in the account except in case specifically mentioned otherwise in the agreement that states otherwise.
- It is the fiduciary duty of the trustee to act in the best interest of beneficiaries.
- According to the state laws prevailing in the particular state, it is the responsibility of the trustee to file annual tax returns. It may at the request of the beneficiary have to file regular accounting.
- All the distributions and expenses which are related to the beneficiary must be done from his trust account only.
Types of Trust Accounts
There are many types of trusts having somehow same functions but serving different purposes. An escrow account, for example, is a type of trust account for real estate, through which a mortgage-lending bank holds funds to be used to pay property taxes and homeowners’ insurance on behalf of the home buyer. The availability of the type of trust depends on the state law that is prevailing in the jurisdiction. It has basic four classifications which includes
#1 – Living Trust
It is the trust that is enforceable during the lifetime of the creator of trust i.e. settlor.
#2 – Testamentary Trust
It is the trust that is enforceable after the death of the settlor.
#3- Revocable Trust
It is the trust having the clause which gives the right to settler to change the agreement of trust or terminate the trust.
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#4- Irrevocable Trust
Under this, there is a restriction on settlor to make any changes in the agreement or to terminate the trust. Once the settlor transfer property under this account, right of ownership is given up.
Thus one has to first decide about the type of trust account it is interested into, and then it has to decide that who should be the trustee, who all will be the beneficiaries and what are all the assets that can be transferred into the trust account.
Steps to Follow While Setting up a Trust Account
Following are the steps which are followed while setting up a trust account:
#1 – Selection of Type of Trust
The first step in setting a trust account is to decide about the type of trust which suits best for the particular person. As stated above a trust may be Living trust, Testamentary trust, revocable trust or irrevocable trust. Type of trust which one chose determines trust account form it should open.
#2 – Appointment of a Trustee
Appointment of a trustee is the second step. A trustee is a person who is responsible for managing your trust assets and executing the terms and conditions of a trust. A trustee can be any person who is mentally competent. It must be remembered that alternate trustee should also be designated who can act as trustee in case of death and incapacity of a trustee.
Generally, a trust department in law firms or bank serves as trustees. In case one is appointing an individual as a trustee then that person should be capable enough to understand the nature of trust and perform his duties efficiently.
#3 – Determination of Assets
The third step is the determination of the assets which a person wants to get placed in trust. There are few assets such as bank accounts, cars, stock, a real estate whose legal title should be changed in the name of a trustee as the trustee is the legal owner of trust property.
Few assets like jewelry and art don’t have any legal title and in such case right in the asset must be transferred to the trustee. It is to be remembered that the powers of the trustee over the assets of the trust must be clearly stated in the trust documents.
#4 – Drafting and Filing of Documents
The fourth step is drafting and filling of the documents. The trust shall be written as per the state laws. The documents should be properly signed and notarized. If in one’s region it is mandatory to file the trust documents with the state then it should file all the documents.
#5 – Bank Process
Lastly one will go to the bank with the trust documents as these documents will instruct the bank about the steps of setting up a trust account which includes the name and the designation of a trustee.
Thus for setting up of the trust solid understanding of the trust laws of the state is required. One should research properly about the trust that the state laws permit along with the rules which govern the operations of the trust. It is risky to transfer the assets in the improperly formed trusts as they can be voided and send your assets into probate. It is always good to consider all the factors and consult a professional before creating a trust account.
This has been a guide to what is Trust Account. Here we discuss its feature and steps required for setting up a trust account along with its types. You may learn more about our articles below on accounting –