Corporate Finance Tutorials
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- Trust Fund
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What is the Trust Fund?
The trust fund is a separate legal entity and is set up by a person, constituting of her wealth (wealth may be cash, property, stocks, jewelry, etc) to be distributed among one or more beneficiaries after their passing. The fund also contains instructions as to how and for what the proceeds of the assets are utilized by the beneficiaries. This is taken care of by a Trustee.
Parties involved in Trust Fund
From the above explanation, it is clear that a typical trust fund has 3 parties to it –
- Grantor – She/he is the person that sets up the fund and contributes assets to it.
- Beneficiaries – They are the people that the grantor wants to receive parts of or all of the wealth that they will leave behind. There can be one or more beneficiaries. In the case of multiple beneficiaries, the proportion and manner in which the assets are to be distributed among them are also envisaged.
- Trustee – A trustee is generally a person who holds assets on behalf of another person(/s) who have entrusted them with their assets. So in a trust fund, the trustee is a person who has been appointed by the grantor to manage and distribute their assets in the manner envisaged by the Grantor.
How does Trust Fund work?
A grantor has some assets that she/he wants her spouse/children/others to have access to but only for purposes that She/he intends for it to be used, for example -fixed allowance for living expenses, college fees, down payment for the purchase of a house, etc.
She/he sets up a fund, with her assets. The trust deed will include (but not limited to) the following details-
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- List of beneficiaries
- What portion of the fund each beneficiary gets, at what time intervals, what purposes the beneficiaries can withdraw from the fund for What purposes the beneficiaries cannot withdraw from the fund for (probably more important than the previous clause).
- She/he hires a Trustee, to act on behalf of her when She/he passes away. The trustee is generally an independent third party who is trustworthy.
- The trustee gets charge of her assets and will hold it on behalf of the beneficiaries until they claim it or until.the time it is distributed as per the grantor’s instructions.
Top 5 Types of Trust fund
Given below are the different types of trust funds.
#1 – Revocable Trust/ Living Trust
As the name suggests, the terms of this trust can be altered even after the creation of the trust. Such funds are generally created when the grantor is alive and the grantor intends to retain access to the assets of the trust fund. The grantor is also the trustee in revocable trusts. Under this arrangement, the income earned from the assets in the trust will accrue to the grantor until the time of their death. Creditors of the grantor will also be able to recover debts from the assets of the fund, till the time the grantor is alive.
Revocable trusts usually change into irrevocable trusts after the grantor dies.
#2 – Irrevocable Trust
An irrevocable trust is one in which, once formed, the terms of the fund cannot be altered or revoked. The grantor will not be considered the legal owner of the assets in the trust fund. In addition to this, the most important point that sets an irrevocable trust apart from a revocable one is that the grantor’s creditors or any litigation judgment against them cannot be claimed against the assets of the trust. An irrevocable trust also reduces the estate tax of the grantor as the assets in this fund is not considered to be held by them.
Which one is better?
Both of them have their advantages and disadvantages. And which is better for you depends on your objective of forming the trust – When the main objective of creating a trust is to make sure that your wealth is not used carelessly by your heirs, it is advisable to go for a revocable trust as it will give you control of the assets till you live.
On the other hand, if you have wealth whose value exceeds the threshold limit for estate tax applicability (which varies from state to state), an irrevocable trust is recommendable.
Apart from the classification given above, there are other types of trust funds that are formed for specific purposes, few of which are listed below –
#3 – Charitable Trust Fund
When the grantor wants his wealth or part of it to be utilized for the greater social good, a charitable trust is formed. The asset pool that is contributed by the grantor is called the Corpus fund, that is generally maintained for eternity. And the income generated from the assets is used to fund charitable causes that the grantor wishes.
#4 – Spend-thrift Trust
Such a fund is formed when the grantor believes that her heir/(s) will not use the wealth they inherit from them responsibly and hence feel the need to appoint an independent entity (the Trustee) to ensure that the assets are only used for the purposes that the grantor would permit. These funds have clauses that do not permit the beneficiaries to use the income from the fund assets against any debt or collateral.
#5 – Generation-Skipping Trust
As the name suggests, this is a tool to transfer your wealth/estate to your grandchildren/great-grandchildren directly rather than passing it onto them through your spouse or children. Such type of trust is generally designed to rid the spouse or children from high estate taxes, in cases where all of them already hold high-value estates.
In conclusion, it can be said that a trust fund is a tool used for family wealth management, family tax planning and making sure that the family and other dependants of the grantor get the maximum use of the wealth that She/he leaves behind.
This has been a guide to what is Trust Fund and its meaning. Here we discuss the 3 parties involved in a Trust fund (Grantor, Beneficiary, and Trustee), how it works and top 5 types of Trusts. You may learn more about Corporate Finance from the following articles –