What Is a Trust Fund?

Definition and Examples of a Trust Fund

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A trust fund is a special type of legal entity that holds property for the benefit of another person, group, or organization. There are many different types of trust funds and many provisions that define how they work.

Learn more about trust funds and their benefits.

What Is a Trust Fund?

A trust fund is often used as an estate planning tool. It's used to minimize taxes and avoid probate, which is the legal process used to distribute the assets of a deceased person.

Generally speaking, there are three parties involved in all trust funds:

How a Trust Fund Works
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  • The grantor: This person establishes the trust fund, donates the property (such as cash, stocks, bonds, real estate, art, a private business, or anything else of value) to the fund, and decides the management terms.
  • The beneficiary: This is the person for whom the trust fund was established. It's intended that the assets in the trust, though not belonging to the beneficiary, will be managed in a way that will benefit them, as per the specific instructions and rules laid out by the grantor when the trust fund was created.
  • The trustee: The trustee, which can be a single individual, an institution, or multiple trusted advisers, is responsible for making sure the trust fund maintains its duties as laid out in the trust documents and according to applicable law. The trustee is often paid a small management fee. Some trusts give responsibility for managing the trust assets to the trustee, while others require the trustee to select qualified investment advisers to handle the money.

How a Trust Fund Works

A trust fund sets rules for how assets can be passed on to beneficiaries. Let's say someone wants to leave money to their grandchildren, but they're concerned about their grandchildren using all the money while they're young. The grandparents might put some assets into a trust that stipulates that funds can be accessed once the grandchildren reach the age of 30. Or they might specify that the funds can only be used for education.

In addition to the wishes of the grantor, trust funds follow state laws. Certain states may offer more advantages than others depending on what the grantor is attempting to accomplish. It's essential to work with a qualified attorney when drafting your trust fund documents. 

One of the most popular provisions inserted into trust funds is the spendthrift clause. This clause prevents the beneficiary from dipping into the assets of the trust to satisfy their debts.

Some states permit so-called perpetual trusts, which can last forever. Other states don't allow these trusts unless they're charitable trusts (trusts that benefit a charitable organization).

Types of Trust Funds

While there are many specific types of trust funds, they fall into two main categories:

  • Revocable: This type of trust is also known as a living trust. These trusts are flexible and can be dissolved. They typically convert to an irrevocable trust on the death of the grantor.
  • Irrevocable: This trust transfers assets out of the grantor's estate, and can't be altered once established. This type of trust has more protections from creditors and more tax benefits than a revocable trust.

The Benefits of a Trust Fund

There are several reasons trust funds are so popular:

  • Intentions: If you don't trust your family members to follow your wishes after your passing, a trust fund with an independent third-party trustee can often alleviate your fears. For example, if you want to make sure your children from a first marriage inherit a lake cabin that must be shared among them, you could use a trust fund to do it.
  • Tax benefits: Trust funds can be used to minimize estate taxes so you can get more cash to more generations further down the family tree.
  • Protection: Trust funds can protect cherished assets from your beneficiaries, like a family business. Imagine you own an ice cream factory and feel tremendous loyalty toward your employees. You want the business to continue being successful and run by the people who work in it, but you want a percentage of the profits to go to your son, who has an addiction problem. By using a trust fund, and letting the trustee be responsible for overseeing management, you can achieve this. Your son would still get financial benefits, but he would have no say in running it.
  • Ongoing transfers: There are some interesting ways to transfer large sums of money using a trust fund, including establishing a small trust that buys a life insurance policy on the grantor. When the grantor passes away, the insurance proceeds are distributed to the trust. That money is then used to acquire investments that generate dividends, interest, or rent for the beneficiary to enjoy.

Key Takeaways

  • A trust fund is a special type of legal entity that holds property for the benefit of another person, group, or organization.
  • There are three parties involved in a trust fund: the grantor, the trustee, and the beneficiary. 
  • A trust fund sets rules for how assets can be passed on to beneficiaries.
  • Trust funds can be revocable or irrevocable. Irrevocable trusts have more benefits. 
  • Trust funds ensure your family abides by your wishes and offers tax benefits. 

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.

Article Sources

  1. Legal Information Institute. "Spendthrift Clause." Accessed July 26, 2020.