Steps to Setting Up a Trust Fund
Establishing a Trust Fund Isn't as Difficult As You Might Think
Now that you've had your question, "What is a trust fund?" answered, let's look at the process of establishing one. For those of you wondering how to set up a family trust fund, this general overview will give you an idea of what the broad process might look like though, of course, the details will differ based upon your own situation and the advice of your attorneys who should be personalizing the terms, structure, and operations of the trust to fulfill whatever purpose or goals you've drawn out for it.
1. Figure Out What It Is You Want Your Trust To Accomplish and How It Is Going to Do It
Why are you going to the trouble of creating a new legal arrangement to restrict a specific collection of property? What it is you are attempting to achieve? Specifically, you need to identify, among other things:
- Who the grantor is (the person transferring property to the trust)
- What the trust corpus is (the assets that make up the trust fund's balance sheet such as cash, stocks, bonds, mutual funds, real estate, or other property)
- Who the beneficiaries and contingent beneficiaries are
- Who will serve as trustee (if you need help, read Three Questions to Ask When Choosing a Trustee for Your Trust Fund; don't forget you can use a corporate trustee such as a bank trust department)
- How the assets will be managed, invested, or treated, including the types, level, and timing of distributions
- Who will manage the assets
- How long the trust will last before terminating and under what conditions it will cease to operate
- Whether the trust is revocable (can be changed) or irrevocable (cannot be changed)
2. Go To A Reputable Estate Planning Attorney with Experience Drafting Family Trusts and Have Him or Her Create a Declaration of Trust and the Trust Instrument in the State Most Beneficial to Your Goals and Objectives
The next step in setting up a trust is going to an attorney in the state in which you want the trust fund domiciled.
This is an important decision because the state laws used to craft the trust will have a profound influence on the way it is overseen by the courts, the rights of the parties who become involved with it in the future, and many other details you cannot possibly imagine at the moment. Though trust law differs from state to state, it has standardized to some degree over the past century thanks to efforts of the Uniform Law Commission, which works to promote uniformity of statutes throughout the United States. Nevertheless, make sure you're choosing intelligently from the outset by talking it over with your qualified advisors. New York, for example, is famous for requiring more formality in its trust creation process than other states, perhaps because, historically, there was so much wealth it simplified the whole affair by drawing a bright line requiring things such as formal transfer of title, rather than mere declaration, when putting assets in trust.
Have the attorney create a declaration of trust and/or the full trust instrument, which is the legal document that establishes the family trust fund and that codifies all of the things we discussed in the previous step. It can be simple and short or long and complex depending on the size of the trust, the number of beneficiaries, and the purpose it is attempting to fulfill.
Use a specialist who understands estate law. This is not an area to take the low bid because the cost of getting it wrong can be years of protracted legal battles among your heirs. Make sure you pick a good name in harmony with the trust purpose because your heirs are going to be stuck with it for awhile. If you need help, you can read more about naming your family trust.
For the sake of convenience, many common trust arrangements have nifty names that are used to refer to the configuration. For example, if the trust instrument contains a provision that forbids the beneficiaries from pledging, borrowing against, or pre-spending distributions from the trust, putting the assets beyond the reach of creditors and making it impossible for the heir to sell off the annuity stream, either intentionally or non-intentionally, it is known as a spendthrift trust.
Some of these are so ironclad and well-drafted that they border on, if not fall into, the immoral (see the Supreme Court of Mississippi's decision in Sligh v. First National Bank of Holmes County in which the victim of a child molester was forbidden from recovering damages against the perpetrator's spendthrift trust, allowing the monster to continue living as a trust fund baby off his late mother's wealth). Another illustration: If the trust holds your assets after death and provides for your surviving spouse, allowing him or her to remain in the home, live off a regular stream of income generated by the trust portfolio, but never touch the principal, which is to be left to the children and grandchildren (protecting them in case the spouse remarries), it is known as a QTIP trust.*
You can generally restrict a trust through the trust instrument in anyway you want, creating incentives for your heirs or rewarding them for certain behavior. You should be careful here because you can get some non-intended consequences (e.g., you say a beneficiary receives a $250,000 payout whenever he or she gets a Bachelor's degree but don't specify the first Bachelor's degree so a clever heir perpetually enroll in new programs, becoming a professional student and never entering the work force as they drain the trust ahead of your intended schedule, taking assets from your other relatives). The exception? Your demands cannot be "against public policy". You could not, for instance, provide distributions any time one of the beneficiaries robbed a liquor store. You could not instruct the trust to disinherit your daughter if she dates a non-white person. You could not say your granddaughter only receives distributions if she puts her children up for adoption. Likewise, you cannot say you are going to disinherit your son, who is gay, unless he marries a woman, as one elderly bigot famously tried to do in New York in 2012, making it the talk of law schools across the country. You might counter, "My money, my rules" but that's not true. You're dead. You don't have any money. The trust does and the trust must abide by minimum standards of decency as set out by society through the courts.
When everything is done and to your liking, sign the paperwork creating the trust. Make your trust declaration, put the trust instrument into effect, and move on to the next step.
3. Register the Trust with the IRS to Receive a Taxpayer Identification Number (TIN)
If the trust is not a grantor trust which the person donating the property is the sole trustee and retains certain powers, such as the right to revoke or modify certain portions of the trust instrument and therefore must report the trust assets and income under his or her personal Social Security Number on his or her Federal and State tax filings, the trust fund will need to request its own taxpayer identification number, or TIN. Just as a business needs an Employer Identification Number (EIN) and a person needs a Social Security Number (SSN), the TIN allows the trust to file its own stand-alone tax returns, open financial accounts at banks, brokerage firms, as well as other institutions, and a variety of other things necessary to conducting day-to-day business.
To receive your trust's TIN, you can complete the process online at the IRS website or you can download Form SS-4, fill it out, and submit it by mail.
4. Transfer the Property You Are Gifting to the Trust Fund by Retitling It and Opening Financial Accounts In the Trust's Name
The next step in setting up your trust fund is retitling the property you want to transfer to it. This might be done as "[Insert Name of Trustee] as Trustee for [Insert Name of the Family Trust Fund] on [Insert Date]". For example, imagine you had 10,000 shares of Exxon Mobil worth $830,000 you wanted to put in trust for your children. You setup the family trust and call it "The John Smith Energy Trust". You name your sister, Ada Smith, as trustee. You go get the stock certificates out of the vault and re-register them with the transfer agent, changing the title listed in the corporations registration records from your name to: "Ada Smith as Trustee for The John Smith Energy Trust, July 30th, 2016" or something comparable.
If you are going to transfer real estate to the trust, you'd go down to the recorder of deeds and sign over the trust the same way:"Ada Smith as Trustee for The John Smith Energy Trust, July 30th, 2016".
If the trust is going to be funded with cash, you'll need to open the bank or brokerage account to which you plan on making the deposit. Let's say you went to Charles Schwab & Company, one of the biggest brokers in the world. You open a Schwab One Trust Account for a minimum of $1,000 or, $0 if you agree to open a linked checking account in the trust's name to which you contribute at least $100 per month. Beyond that, the trust account behaves, for all intents and purposes, as if it were a brokerage account in the sense you can buy and sell assets according to whatever rules were laid out in the trust instrument (e.g., if it said you can only regularly buy shares of Coca-Cola, you can't start trading options unless you want to get sued by the beneficiaries for a breach of fiduciary duty and very well may be required to pay back any losses you incur resulting from your verboten transactions). Schwab will require a copy of the trust instrument to have in its records a list of the provisions restricting your behaviors.
5. Take Care of the Trust Administration and Accounting Records
Finally, the last step in setting up your trust is administering it in accordance with the trust instrument by keeping detailed records, including accounting records, so if there is ever a lawsuit or discrepancy, the paperwork is in order. At some point in your lifetime, or at the time of your death, you'll need to turn over these responsibilities to someone else.
While you can separate the tasks into specific functions and source them with different people or institutions (e.g., hire this firm to manage the money, this firm to serve as co-trustee in its institutional capacity, this firm to hold the assets in custody, this firm to take care of the accounting and file the taxes), many financial service firms offer all-in-one fee packages, combining corporate trustee services with administration, accounting, and investment management. As I mentioned in another recent article on trust funds, Vanguard, famous for its index funds, will do this for a family trust provided the minimum balance is $500,000 and the minimum fees, at the time of this writing, are $4,500 for the investment management itself + the look-through fees on the Vanguard funds (e.g., the mutual fund expense ratios) + a $2,500 per trust registration fee for serving as sole or co-trustee, plus any service fees. In almost all cases, you'd be looking at between $7,000 to $15,000 for a smaller-size trust, which is more than fair considering the risk the firm must take upon itself for serving as your stand-in for what may very well turn out to be multiple generations of your family.
* I'd go so far as to say almost everyone with children from an earlier marriage who doesn't want them disinherited, purposely or accidentally, should utilize a QTIP trust.