Investing Money Held In a Trust

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Establishing a trust is a well-known method of passing on any wealth or assets you may have, which essentially bypasses your state's probate process. Generally, trusts originally consist of assets accumulated by the grantor (the person or people that established the trust). These instruments are then administered by a third party (the trustee) for the beneficiary.

Trusts are not simply storage containers for assets. Money held in a trust doesn't need to sit in stasis—it can be put to work unless expressly forbidden from doing so.

Methods For Using a Trust

There are several categories of trusts, such as inter vivos trust funds (a living trust) and testamentary trust funds (established when the grantor dies). Revocable trusts are able to be altered or canceled until the time of the grantor's death, at which time they become irrevocable (they cannot be changed or canceled).

Unless the trust instrument—the document that governs the behavior of the trust—specifically permits or forbids investing actions, a trust fund's capital can be invested in any asset that would be consistent with fiduciary duties the trustee owes to the beneficiaries of the trust.

In some cases, investors or executives who accumulate a large position in a blue chip stock will transfer some of the shares to a trust for family members, which allows them to live off the dividends as passive income. In other cases, all of the worldly assets left behind in an estate are sold directly or put up for auction so that the proceeds can be invested in a diversified portfolio of stocks, bonds, and/or real estate. 

It's not unusual for controlling interest in a private operating business to be held in trust for the shareholders. These owners use the trust to ensure their spouses and/or children are able to live off the fruits of their labor without borrowing against their shares, in which case a spendthrift trust is particularly handy.

Considerations For Trust Funds Investmentments

If you are setting up a trust fund, the investment criteria you are going to establish for the wealth you are gifting is going to depend on several factors. For example, you might want the trust to retain all of its dividend, interest, or rental income for many years.

This is common when a beneficiary child is a minor, and you don't want payouts to begin until later in life. If this is the case, you are going to want to invest the money held in trust in a way that minimizes taxes because trust funds are subject to compressed tax rates. 

That is, it doesn't take much dividend income to reach the top marginal tax bracket. This means you may think about prioritizing ownership of stocks that don't pay dividends or using tax-free municipal bonds.

Do you plan on maximizing distributions in the most tax-efficient manner? If the recipient is in a lower tax bracket, it might be wise to prioritize ownership of high yielding dividend stocks as the beneficiary may be exempt from dividend taxes entirely depending upon his or her household income, thanks to recent changes in the tax code.

If you want to keep control of a specific operating asset, property, or business in the family, you could have your trustee hire a firm to run the asset, then instruct the trustee to store any cash income in Treasury bills. 

The Process of Investing From a Trust Is Straightforward

If you are setting up a trust fund, the actual process of investing money held in trust isn't that difficult. You'll need the trust instrument and documents proving the creation of the trust. Additionally, you might need the tax identification number you've received from the IRS to track the trust's taxes, which you are required to file each year. 

The trustee, acting on behalf of the trust, then opens a bank or brokerage account in the trust's name and uses the account to acquire assets. Depending upon the specifics of the trust, the trustee can either manage the money themselves or outsource the investment of the money in the trust to a registered investment advisor.

If you are establishing a trust, with the intent of using it to grow in value, you might consider provisions requiring a licensed investment professional if you don't believe your trustee can fulfill this portion of their duties.

Options for Investing From Trusts

Smaller trusts are probably going to hold investments such as index funds or other mutual funds—while larger trusts are likely going to be individually managed accounts that invest directly in securities rather than through pooled structures. A possible exception could be an allocation to private equity funds or hedge funds.

You could open a trust fund account at a brokerage firm such as Charles Schwab. Depending upon the restrictions in the trust instrument and documents, it would otherwise look like a normal brokerage account. The firm could buy stocks, mutual funds, trade ETFs (exchange-traded funds) or hold REITs (Real Estate Investment Trusts) for the account.

You could open the trust account directly with a mutual fund company such as Vanguard. Vanguard has varying rates and fees for different types of investments. They can be very reasonable for the service if you need a limited touch trust that invests in plain vanilla assets.

Investing money in a trust isn't much different than investing any other type of money—the inherent problems with investing such as asset allocation, market timing, valuation-based acquisitions, diversification, and tax-efficiency are similar. The key is to make sure you don't run afoul of the restrictions that may be set in place in the trust instruments.

Article Sources

  1. Internal Revenue Service. "Clarification to 2018 "What Is Your Maximum Capital Gain Rate?" Table." Accessed Jan. 28, 2020.