Wills & Estate Planning

What Is a Trust Fund and How Does It Work?

By Cari Wira Dineen Jun 15, 2022

In this article

What Is a Trust Fund?

How Does a Trust Fund Work?

What Are the Benefits of a Trust Account?

What Are the Disadvantages of a Trust Fund?

Trust Fund vs. a Will

Types of Trust Funds

Who Needs a Trust Fund?

How to Open a Trust Account

Frequently Asked Questions

The Bottom Line

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 writing your last will and testament 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.

How do trust funds work? What is a trust fund, exactly?

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.

Read on for the definition of a trust fund, how a trust fund works and whether you might need one. 

What Is a Trust Fund?

Trust Fund Definition

A trust fund is an estate planning tool. It’s 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, trustor, settlor or trust maker. If you set up a trust through your will, you could also be called the testator or decedent. This person chooses the rules behind the trust and decides what property the trust will own (by transferring assets into the trust’s name).

  • The person you ultimately want to receive your money or property is your beneficiary. Being named a beneficiary of a trust is different from owning property, though, because there are generally rules attached. For example, a trust might allow a beneficiary to live in a home owned by that trust, but not rent it out or sell it. Depending on how the trust is set up, beneficiaries often end up inheriting the trust’s assets, according to some trigger like age—for instance, inheriting money when the person turns 21.

  • The person or entity you want to oversee the money and fulfill the various responsibilities is the trustee. This person doesn’t actually own the property in the trust but rather oversees the distribution of the property to the beneficiaries and makes sure that the stipulations put in place are being followed. Trusts can have multiple or co-trustees, or even institutional trustees (meaning that a company oversees the administration of the trust). Many trusts name successor trustees in case the first-choice trustee becomes unavailable.

In many cases, the trustee receives some sort of compensation for the effort, like a management fee.

Related Articles Do You Need Life Insurance? Term vs. Whole Life Insurance: What's the Difference? How Much Term Life Insurance Do I Need?

How Does a Trust Fund Work?

A trust fund essentially transfers ownership of the assets you put into it to the trust itself. When you create a trust, you are the grantor and often the first trustee, and you set the rules around how the assets in the trust can eventually be distributed. 

Another trustee later takes over, often at your death, and oversees the trust to ensure that your wishes are being respected. The trustee must act in the best interest of the trust and the beneficiary at all times—it’s a fiduciary duty. The beneficiary receives your distributed assets according to the rules of the trust, as administered by the trustee.

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.

Putting assets in a trust lets you pass property to someone in a structured way, where you can impose rules even after you’re no longer around. For example, you might say that your beneficiary can’t use the money from the trust fund to pay off debt. Or you might impose rules on how old the beneficiary needs to be before they gain control over the money.

Trusts can shelter assets from estate tax and from creditors after you’re gone. They’re also a very private way to transfer wealth because only the trustee and the beneficiaries know the contents of the trust and the rules around their distribution. Compare that to probate, which is a matter of public record.

What Are the Benefits of a Trust Account?

You consider putting money in a trust if you want it to go to a specific person in a specific manner after you’ve passed away.

After all, accounts like your 401(k) may let you assign payable on death beneficiaries, but your real estate, cash and personal stock accounts generally 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. This can include a “charitable annuity trust” or “charitable remainder trust,” a GRIT, a qualified personal residence trust and more. We’ll explain those more in depth, below. Trusts may also be able to optimize estate tax planning.

  • Protect your privacy. Unlike a will that goes through probate court, which leaves public records, trusts are private. That means they avoid probate. If you want to make sure that people in your extended network—or the media, if you’re famous or of public interest—don’t have access to the details of this inheritance, you could go with a trust. 

For all of these scenarios, you can set up a trust with specific instructions with the help of a qualified professional.

What Are the Disadvantages of a Trust Fund?

  • There are more strings attached to your heirs inheriting your property.

  • The cost of creating a trust can be prohibitive for some people.

  • It's an inconvenient extra step if you're just trying to arrange a basic set of instructions for where your property should go after you pass away.

  • Administering the trust fund may be more complicated than simply transferring assets to a beneficiary after you pass away. For example, a trustee may need to make regular distributions to a beneficiary and keep track of certain milestones (for example, when the beneficiary turns a certain age.)

  • Although trust funds may make sense in some cases because of the tax benefits, living trusts (also known as revocable trusts) don't actually confer the same major tax benefits as irrevocable trusts.

Trust Fund vs. a Will

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 make a will for free online.)

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 the legal process of 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.

Types of Trust Funds

As with many areas of financial planning, you’ve got choices.

What’s an Irrevocable Trust?

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.

What’s a Revocable Trust?

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. Also called “living trusts,” these trusts take effect when you’re still living.

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.

Asset Protection Trust

An APT is a kind of irrevocable trust that exists to protect assets from creditors. Unlike many other types of trust, the trustee that you select has full control over the assets in the trust. You essentially relinquish ownership of your assets when you put them into an APT. Since you no longer own that property, people and entities to whom you owe money can’t seize them. 

Only 17 states, including New Hampshire, Tennessee, and Virginia, allow APTs. Many people choose to set them up outside of the U.S. as well.

Blind Trust

Similarly to an APT, a blind trust cedes complete control, other than the power to terminate the trust, to the trustee. The nature of a blind trust obscures the content of the trust from the beneficiaries. People who work in the public eye often use blind trusts to conceal their assets and reduce the appearance of conflicts of interest.

Generation-Skipping Trust

A GST is set up so the assets in the trust pass directly to the trustor’s grandchildren, or anyone who is at least 37.5 years younger than the trustor (other than a younger spouse). GSTs are typically a play to save on taxes. This kind of trust helps avoid having to pay estate and/or inheritance taxes more than once when it passes from the trustor to their kids and then to their grandkids.

Grantor-Retained Annuity Trust

A GRAT is a type of irrevocable trust that essentially stops the appreciation of assets so that when the estate passes to the beneficiaries, they won’t owe estate or gift taxes. The grantor typically places assets that are likely to appreciate in value, like stocks, into the GRAT for a set number of years. During the term of the GRAT, the grantor receives annuity payments from the trust equal to the original value of the assets when they were put into the trust. When the term ends, the beneficiaries receive the remaining assets (basically the appreciation of the original assets) in the GRAT tax free.

Individual Retirement Account Trust

To create an IRA trust, you can name a trust as the beneficiary of your IRA assets when you pass away. That way, you can set rules around how your beneficiaries manage your IRA assets.

Land Trust

A land trust transfers ownership of a piece of property or a mortgage into the trust while the grantor is still alive. Land trusts are revocable trusts. There are two types of land trusts that correspond to the two typical reasons people create land trusts. A title-holding land trust allows a property owner to obscure their land ownership. A conservation land trust exists to protect natural resources, historic property or ecosystems from development.

Marital Trust

A marital trust is an irrevocable trust that allows a tax-free transfer of assets in the trust to the surviving spouse when the first spouse passes away. When the second spouse dies, the assets may be subject to estate tax before being distributed to the second spouse’s heir. 

Medicaid Trust

Medicaid trusts are irrevocable trusts that effectively exclude assets from a person’s net worth so that they don’t exceed the asset limits to qualify for Medicaid. The purpose of a Medicaid trust is to allow a disabled and/or aging person to receive long-term care through Medicaid either in their home or in a facility. In order for a Medicaid trust to fulfill that purpose, it must be established at least two and a half years before the grantor needs long-term care.

Special Needs Trusts

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.)

Charitable Remainder Trusts

These types of trust funds could potentially shield money from taxes while passing down money to a charity you care about. With a charitable remainder trust, you can donate your assets to a charity, which serves as the trustee and manages those assets, even while you’re alive. When your investments produce income, the charity would pay you (or another beneficiary) those proceeds. This would keep going on for a certain period of time, often for the life of the grantor.

In other words, you could “pre-gift” a charitable contribution now to receive an immediate tax benefit, and also shield your assets from estate taxes by reducing the size of your estate upon your death (at which time the funds would belong to the charity in full).

Testamentary Trusts

Testamentary—like last will and testament. You can actually create a testamentary trust through your will to control what happens to your assets and how your property should be inherited. If you go this route, then the probate court would examine your will after you die. Provided that the court accepts your will and agrees to fulfill the instructions you’ve laid out, that’s when any trusts would take effect, if you dictated that they should be created through the document.

Qualified Terminable Interest (QTIP Trusts) 

This kind of trust specifically helps ensure that the surviving spouse can remain in their home until he or she dies, but doesn’t allow that spouse to sell the property. This is particularly useful for blended families. So, let’s say you are married, and have an adult child from a prior marriage. Now let’s say that you want to leave the house to your child when you pass away. You might use a QTIP trust to make sure that, if you passed away, your spouse wouldn’t be “kicked out” of the house where you’d been living together. When your spouse passed away after however many years, that’s when your child would be able to inherit the house.

Spendthrift Trusts

This is a broad term to describe trust funds that are constructed to let the trustee withhold money to the beneficiary if he or she believes that the beneficiary would waste it or have it collected by a creditor. For example, this might make sense if you wanted to pass down money to children but weren’t sure they’d be responsible enough to spend it well. Or, say, if you wanted to pass down money to someone with a substance abuse or compulsive spending problem. 

Grantor Retained Income Trusts (GRITs)

This type of trust fund is most relevant for the very wealthy. The idea behind this type of trust is to try to reduce how much the government values your property for estate tax purposes. If your estate is worth over a certain amount, you might have to pay estate taxes—that’s why GRITs let the trustor earn interest income from assets in the trust yet don’t count the value of that property in the grand total for estate tax purposes.

Qualified Personal Residence Trusts

Similar to how GRITs are constructed to help reduce your tax liability, qualified personal residence trusts serve a similar purpose. These are a kind of irrevocable trust that can be used to keep your primary or vacation home “out” of your estate for tax purposes. Because it’s an irrevocable trust, that means you can’t go back and reclaim it, but this maneuver can be useful if you want to transfer a house to family members.

Who Needs a Trust Fund?

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 2021, the exemption was $11.7 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.

How to Open a Trust Account

To create a trust fund, you’ll need the following information:

  • Name of the trust

  • Description of the trust, namely why the trustor is creating it

  • Trustee name plus any directions about replacing a trustee if he or she can no longer serve

  • Beneficiary name

  • List of property owned by the trust fund

  • Duties and abilities of the trustee (for example, whether the trustee can buy or sell property contained in the trust or how the process works if the trustee wants to resign or transfer responsibilities to someone else) 

  • Details on what should happen if the trustor, trustee or beneficiaries passed away or became incapacitated

You’ll need to choose what kind of trust you want to set up, which will depend on your goals and the type of property you want to put into the trust.

Then you’ll need to create the trust document, which is the source of truth for information about the trust and how it operates. It will establish who the grantor, trustee, successor trustee, and beneficiary or beneficiaries are, and the assets that the trust contains. Once the trust document is complete, you must have it notarized and sign it. Your state may have additional rules about witnesses or extra documentation to file when you establish a trust, so make sure you’re fulfilling those requirements.

Next, you’ll fund the trust. Using the trust documents, you can open a bank account in the trust’s name and start transferring your assets into the account. Finally, for any assets that are payable or transferable upon death, like retirement accounts, you can name the trust as the beneficiary. That way, when you pass away, those assets will go into the trust.

You can set up a trust on your own or use an online estate-planning service to guide you through the process. But if your situation is complex, it might be best to call in an expert.

When you should hire a professional

Most people who want to set up a trust fund could probably benefit from the expertise of an estate attorney.

You may want to work with an estate attorney if:

  • You’re not sure how to correctly fund the trust

  • You have a very large estate and think you might incur estate tax

  • You have life insurance policies with large death benefits

  • You want to set up an irrevocable trust

  • You want to set complex conditions about how the assets are distributed and used

There are a few different ways to use an estate attorney to set up a trust. You can hire someone to guide you through the whole process, or you can prepare the trust document yourself and have an estate attorney review it.

If you decide you want to work with an attorney, look for one who specializes in the preparation of trusts, because estate planning is a broad, complex field.

Frequently Asked Questions

Can a Trustee Withdraw Money From a Trust?

When contemplating trust funds, many people become nervous that a trustee might ransack the trust for personal purposes. To be clear, this is illegal. Specific laws vary depending on where you live, but a trustee is never allowed to withdraw funds for his or her own personal use. That's because the trustee has a fiduciary responsibility, which means that he or she is bound to act in the best financial interest of the beneficiary and must follow the rules and terms of the trust agreement.

The trustee is the only person (or people) who can take money out of a trust account.

How Much Money Do You Need for a Trust Fund?

Setting up a trust is complex and does cost money. That's why many people get stalled at the "how to set up a trust fund" stage. 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. A very basic trust fund can involve little more than a few pages of paperwork.

Do Trust Funds Grow? Do Trusts Earn Interest?

A trust fund is a vehicle that contains other assets, meaning that not every trust fund is the same. You need to put assets or property into a trust fund. So, if the assets you have inside the trust fund grow (for example, investments that grow over time or earn interest), then yes.

A trust account can be as simple as a bank account where the money is owned by a trust rather than an individual. Like other bank accounts, some trust accounts can also earn interest. Generally speaking, this interest is paid to the account beneficiary.

How Long Do Trust Funds Last?

Trusts can last for a long time, but the exact rules tend to vary by state. For example, in many places the trust can't keep going more than 21 years after the death of a potential beneficiary who was alive when the trust was set up. That's called the "rule against perpetuities" and is intended to restrict trusts that could theoretically last forever.

That said, some states like California have made their own related but different laws. In California, for example, there's a version of the rule that just says that a trust can last about 90 years. Delaware lets trust keep going for up to 300 years, though, and some states don't have any expiration. These neverending trusts are sometimes called "dynasty trusts." They're chiefly used by the super rich because of the tax benefits; you'd only need to pay gift or estate taxes when you transfer money into the trust, but then many subsequent generations would be able to inherit property without paying estate taxes.

Trusts can terminate early if they run out of property, or if the probate court orders it to end. (That's rare.)

How Do You Get Money Out of a Trust Fund as a Beneficiary?

It depends on the rules of the trust. You may only be able to access a certain amount of money each year, or you may need to wait until you’re a certain age to take ownership of the assets.

The trustee is in charge of managing the assets while they are in the trust, and it is their job to distribute the assets to you according to the rules of the trust.

Many trustees set up a checking account and make distributions to the account. You can then withdraw money as needed. Alternatively, you may be able to withdraw funds directly from the trust account if the grantor wrote that into the trust document.

What Kind of Assets Can Go Into a Trust Fund?

It depends on the type of trust, but most types of assets can be transferred into a trust fund. Cash, securities like stocks and bonds, and physical property like technology and art can go into a trust fund. You can also transfer the deed to your home or car to your trust fund. 

Life insurance policies and retirement accounts like IRAs and 401(k)s can’t be transferred into a living trust directly. But you can set them up so that the trust is the beneficiary. That way, when you pass away, these policies and accounts move into the trust. 

Can Creditors Seize Assets From a Trust?

An irrevocable trust protects your assets from creditors after your death.Since it cannot be changed during your lifetime, the money is under the trust’s control rather than yours. Therefore, it can’t be used to satisfy your debts.

A revocable trust, on the other hand, does not protect your assets from creditors. Since you can make changes to a revocable trust during your lifetime, it will be counted among your personal property.

The Bottom Line

If you don’t want to create a trust, you probably will need to relinquish some control over how your assets are distributed. The simplest way to pass down property to a loved one without a trust is through a will. If you go this route, you may be subject to more taxes and your estate will need to go through the probate process.

That said, it’s an opportunity to share your wishes in broad strokes and to designate a legal guardian to watch your children. (Hint: Fabric lets you create a will online, for free.) 

Fabric exists to help young families master their money. Our articles abide by strict editorial standards.

Fabric by Gerber Life exists to help young families master their money. Our articles abide by strict editorial standards.

Information provided is general and educational in nature and is not intended to be, and should not be construed as, financial, legal, or tax advice. Laws of a specific state or laws relevant to a particular situation may affect the applicability, accuracy, or completeness of this information. Federal and state laws and regulations are complex and are subject to change. We make no warranties with regard to the information or results obtained by its use, and disclaim any liability arising out of your use of, or reliance on, the information.

Fabric by Gerber Life offers a mobile experience for people on-the-go who want an easy and fast way to purchase life insurance.

Written by

Cari Wira Dineen

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