Trust funds often get a bad rep—too often, we assume the people who inherit them are spoiled, entitled and ultra wealthy.
But that’s not actually true (or doesn’t have to be). Sure, trust funds might be a good place to park your cash if you’re a millionaire. But you don’t have to be rich to make a trust fund a part of your financial toolkit.
A trust fund can be a useful component of your estate planning, (in addition to setting up your will and picking your children’s guardians). That's especially true if you want to help your money get to your kids without a hitch when you pass away.
We spoke to Alexander Joyce, CEO and president of ReJoyce Financial, a financial and estate planning firm in Indianapolis. He shared how you might go about setting up your kid (and your cash) with a trust.
A trust is a legal entity that can hold property on behalf of someone or some group. If you are the person who’s creating a trust, you’re called the grantor. The person you ultimately want to receive your money or property is your beneficiary. The person or entity you want to oversee the money and fulfill the various responsibilities is the trustee.
In many cases, the trustee receives some sort of compensation for the effort, like a management fee.
Trust funds can hold lots of kinds of property, from cash to investments to real estate to artwork. They can even hold whole businesses in them. Basically anything that is valuable can go in a trust fund.
OK, so, trust funds are “entities.” What does that mean? Trust funds let you pass property to someone in a structured way, where you can impose rules. For example, you might say that your beneficiary can’t use these funds to pay off debt. Or, you might impose rules on how old the beneficiary needs to be before she gains control over the money.
You might use a trust fund if you have money that you want to go to a specific person in a specific manner after you’ve passed away.
After all, your 401(k) and your life insurance policy let you assign beneficiaries, but your real estate, cash and personal stock accounts don’t.
Here are some common reasons people choose to create trust funds:
Designate exactly who should receive their estate. Perhaps you’ve gotten remarried and want to make sure your children (but not your new spouse’s children) get your money.
Set limits on how old a beneficiary needs to be. Legally, your children could gain access to money you leave behind at 18. If you don’t think they’ll be ready, you could set up a trust that doesn’t grant access until they’re 21, or 25, or 35, or whatever.
Specify how the assets can be used. You might stipulate that the money can only be spent on education.
Pay out at intervals. You can prevent your beneficiaries from blowing all the money at once by instructing that a trust be paid out at intervals. Maybe they get one payment when they turn 25, then at 35, and again at 45.
Insert a “spendthrift” clause. You could stipulate that the assets in the trust can’t be sued to satisfy debts. In other words, say this person spent a ton of money and got into massive debt. He couldn’t utterly bankrupt himself by sapping up all the trust fund money to pay it off.
Skip a generation. You could specify that your money should jump a generation and go directly to your future grandchildren.
Designate a pro to manage your affairs. Let’s say you have a family history of Alzheimer’s or dementia. You could use a trust to set up a framework for a professional to manage your affairs. If you were to become incapacitated, he or she would step in.
Protect a business you own. Let's say you run a business and want to protect your employees’ jobs. You also want to pass down the profits to one of your kids. You could name a trustee to put in the effort of overseeing the management of the business and pass on profits to your child. (Here's what entrepreneurs should know about life insurance.)
Reap tax advantages. In some cases, a “charitable annuity trust” or “charitable remainder trust” could potentially shield money from taxes while passing down money to a charity you care about. Trusts may also be able to optimize estate tax planning.
For all of these scenarios, you can set up a trust with specific instructions with the help of a qualified professional.
A trust in no way replaces a will. A will is the only way you can name an executor and legal guardians for your children. Without a will, the state where you live will divide up your property and assets as it sees fit.
In fact, a will is the most important part of your estate plan. (Psst: Fabric lets you create a personalized will in only about five minutes and also includes instructions to make it legally binding.)
That said, having a will and a trust can help ensure that your money not only goes to whom you choose, but also in the manner you choose.
Once you have a will, you might set up a trust because wills are subject to probate. That means creditors, other relatives or even your children could challenge what it says during the probate process.
For example, say your will allocates 40 percent of your estate to your son, 40 percent to your daughter and 20 percent to charity. Your kids can legally dispute the will and try to cut the charity out. Or your daughter can sue your son if she feels she is entitled to more than 40 percent.
A trust, while more complex to set up, can bypass the probate process down the road.
As with many areas of financial planning, you’ve got choices.
This kind of trust, as the name implies, can’t be modified or dissolved later. Once you place assets in the trust, they are no longer yours. They are under the care of a trustee. That can include a bank, attorney or other entity set up for this purpose.
The good news? Since the assets are no longer in your direct possession, you don't have to pay income tax on any interest made from the assets, or estate taxes.
Similarly, an irrevocable trust would protect your assets from creditors or lawsuits. If you create an irrevocable trust to donate your assets to charity, you can take a charitable income tax deduction for those assets, too.
Another plus of an irrevocable trust is that, because this money is “no longer yours,” it’s shielded from nursing homes. If you end up needing long-term care, this money won’t get sapped by an expensive facility. That said, if you lock up a lot of your assets in an irrevocable trust, you might not have the money you need for living expenses down the line!
While there are benefits to creating an irrevocable trust, the biggest negative is you can’t make any modifications. You can’t get that money “back” later, even if you really need it.
This is the opposite of an irrevocable trust, as you might’ve guessed from the name. You can revoke it later, plus you can make modifications.
Of course, that means you don’t get the same tax benefits as an irrevocable trust, but you maintain a lot more flexibility. This kind of trust still gives you the ability to set rules on who should inherit your assets, and how.
You can also set out guidelines for a future trustee. For example, if you fear you might become physically or mentally incapacitated, you could manage your own assets but have a trustee in the wings to step in if needed.
One reason to consider a trust fund is if you have a child with special needs. You can help ensure he receives detailed care through a trust, even if you were to pass away unexpectedly.
You can designate the special needs trust as the beneficiary of your life insurance policy, and not the dependent directly. This has a few advantages. First, if your dependent isn't capable of managing the money, it puts someone else in charge. Plus, making the trust the beneficiary might help you stay eligible for as many government resources as possible.
(If you’re caring for someone with special needs, you’ll likely want to work with an attorney who specializes in special needs estate planning.)
Well-off people often use trusts because they can create a shield for estate taxes.
The government imposes a maximum amount that you can bequeath to someone without incurring federal gift or estate taxes. In 2018, the exemption was $11.2 million per taxpayer. So if you’re really, really rich, a trust fund can be a good way to gift money without your heirs having to pay a hefty tax.
So, yeah, there’s a reason many people associate trusts with one-percenters. That said, there are plenty of uses for the rest of us, too.
Setting up a trust is complex and does cost money. Many attorneys will charge anywhere from $1,000 to $5,000 to create a new trust. The price will depend on where you live and the complexities of your situation.
You could also consider using online preparation services, such as LegalZoom or Quicken, to reduce costs. While this option can be more affordable, you should still consult with a licensed attorney if you need legal advice.
Fabric exists to help young families master their money. Our articles abide by strict editorial standards.
This material is designed to provide general information on the subjects covered. It is not, however, intended to provide any specific legal advice or to serve as the basis for any decisions.
We are not a law firm, are not licensed to practice law in any jurisdiction and do not provide any legal advice. If you do need legal advice for your specific situation, you should consult with a licensed attorney and/or tax professional.
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