Trust Fund

Updated on March 27, 2024
Article byWallstreetmojo Team
Edited byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Trust Fund Meaning

A trust fund is a legal entity formed as part of an estate planning tool which holds a grantor’s assets and duly distributes them to the inheritors after the grantor passes away. These trusts can help settle the inheritance outside of court by ensuring their distribution as per the terms of the agreement.

Different types of trust funds attract distinct advantages, including tax efficiency, protection from creditors and regular income payments to minor beneficiaries.

Key Takeaways

  • A trust fund is defined as an entity under which assets of an individual are transferred to allow their inheritence legally. Such a fund is created by parents, or grandparents to pass down their wealth to family members or dependents. An entity can also form a trust to safeguard its assets.
  • The parties involved in a trust fund are a grantor, beneficiary and trustee. Grantor is the person whose assets are to be inherited.
  • Beneficiary refers to the person who would inherit the grantor’s assets. Examples of beneficiary include family members or a charity. The trustee being an impartial third party, manages the underlying assets of the trust on behalf of the grantor.
  • A grantor has to work out several details while opening a trust such as the nature of the trust, number of beneficiaries, total asset under management, conditions to inheritance, tax planning, etc.

How Does Trust Fund Work?

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As an estate planning tool, a trust fund allows individuals to legally transfer their assets to the beneficiaries without much hassle. Otherwise, if an individual passes away without a trust in place, inheritors would most often need the help of a court to acquire their inheritance.

The parties involved in a trust fund are a grantorGrantorA grantor refers to a person who has created a trust to manage his/her assets and legally transfer them to the beneficiary to avoid inheritance issues. For instance, a grantor could be a father who has created a trust to control and manage his real estate property, money, and investments and transfer them to his family upon his demise. Since it is a legal process, management, taxation, and transfer terms are specified in the agreement or a deed.read more, beneficiary and trusteeTrusteeA trustee is an individual or institution with legal authority to manage the trust property and assets on behalf of the settlor to benefit the beneficiary. They have complete control over the trust assets until they get transferred to the beneficiary. The administration of assets goes as per the directions of the trust. read more. The grantor is the person whose assets are to be inherited. As such, the grantor sets up a trust fund with the help of an attorney. These days one can set up trusts on their own as well using web applications and sources.

Beneficiary refers to the person who would inherit the grantor’s assets. Examples of beneficiaries include family members or a charity. The grantor, along with the estate planning attorney, prepares a trust agreement, determines its terms and appoints a trustee.

The trustee being an impartial third party manages the underlying assetsUnderlying AssetsUnderlying assets are the actual financial assets on which the financial derivatives rely. Thus, any change in the value of a derivative reflects the price fluctuation of its underlying asset. Such assets comprise stocks, commodities, market indices, bonds, currencies and interest rates.read more of the trust on behalf of the grantor. When the grantor passes away, the trustee dutifully transfers them to the beneficiary as per the terms of the trust agreement. Therefore, it is highly essential to select a trustworthy trustee who’d ethically observe fiduciary duties even when the grantor is no longer around.

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Features of Trust Fund

Let us look at the features of trust funds which will throw light on their advantages as well.

Top 5 Types of Trust funds

Given below are the different types of trust funds.

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#1 – Revocable Trust/ Living Trust

One can alter the terms of this trust as long as the grantor lives. The grantor also retains ownership and access to the assets under the trust. In most cases, the grantor assumes the role of a trustee in revocable trusts.

Under this arrangement, the income earned from the assets in the trust will be taxed as part of grantor’s income as long as the grantor lives. Revocable trusts usually change into irrevocable trusts after the grantor passes away.

#2 – Irrevocable Trust

The terms of an irrevocable trust cannot be changed or revoked in most cases once the trust is formed. The grantor losses ownership of the assets once they are transferred to an irrevocable trust. As such, the grantor will not be considered the legal owner of the assets under the trust. In addition, any creditors of the grantor cannot hold a claim against the these assets. An irrevocable trust also reduces taxes as the assets in the fund are not considered to be held by a grantor. Since the terms cannot be easily revoked, one must think it through before opting for this type.

#3 – Charitable Trust Fund

When grantors want their wealth or a part of it to be utilized for a greater good, a charitable trust is formed. The asset pool that the grantor contributes often forms the part of the corpus fund, which is generally maintained for eternity. The income generated from the assets is used to fund charitable causes.

#4 – Spend-thrift Trust

Such a fund is formed when grantors believe that their heirs cannot responsibly handle their inheritance. Hence, they feel the need to appoint an independent entity (trustee) to ensure that the assets are used only for purposes that the grantor has permitted in the deed. These funds have clauses that do not permit the beneficiaries to use their inheritance as collateral.

#5 – Generation-Skipping Trust

This is a tool to transfer your wealth to your grandchildren/great-grandchildren directly rather than passing it down through their parents. They generally save the spouse or children from high estate taxes when they are of high value.

#6 – Others

There are many other types of trusts other than those mentioned above that can help with the peculiar needs of inheritance.

FAQs

What is a trust fund, and how does it work?

A trust fund is formed by individuals or entities to neutrally and legally transfer their belongings to their inheritors. It is formed by the grantor of an inheritance who prepares a deed dictating the terms of the trust. Thereafter, a trustee is appointed who manages the trust as per the deed and transfers the assets to the beneficiaries.

Is a trust fund a good idea?

Trust funds are an essential estate planning tool that allows the legal transfer of wealth. It ensures that the assets remain in safe hands and are well-managed by a neutral party until the beneficiary takes their ownership. In the absence of trusts, beneficiaries will have to head to a court to gain access to their inheritance which will be expensive and time-consuming.

How much money do you need for a trust fund?

Earlier, trust funds were considered restricted to high-net-worth individuals with their massive wealth requiring elaborate estate planning. However, today, middle-class groups have also started opting for trusts. Normally one can start the fund with any amount, although it may vary amongst estate planning companies, portals and platforms.

This has been a guide to what is Trust Fund is, and its meaning. Here we discuss the 3 parties involved in a Trust fund (Grantor, Beneficiary, and Trustee), how it works, and the top 5 types of Trusts. You may learn more about Corporate Finance from the following articles –

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