What Is a Trust Fund and How Does It Work? Definition and Overview

There are several ways to set up a financially secure future for your loved ones. Trust funds, for example, can help you set your children or grandchildren up for future financial success. Also, contrary to popular opinion, they aren’t necessarily just for the very wealthy. In fact, you can open a trust regardless of your net worth if you’ve got a specific plan in mind.

A financial advisor can help you set up a trust or answer other questions about estate planning.

What Is a Trust Fund?

A trust fund is a legal arrangement that allows a person or entity to hold and manage assets on behalf of someone else. The person who creates the trust, known as the grantor, transfers assets into the trust. They designate a trustee to manage these assets for one or more beneficiaries. People use trust funds to manage and protect wealth, but you don’t have to be ultra-wealthy. Trusts can hold a wide range of assets, including cash, investments, real estate, or business interests. The trust includes terms to control how and when to distribute those assets.

One of the defining features of a trust are the rules set out in the trust document. These rules specify who benefits from the trust, what assets it contains and under what conditions it makes distributions. Trsut structures vary depoending on the purpose they serve. This includes estate planning, tax management or providing long-term financial support for children or dependents.

How Do Trust Funds Work?

There are three parties who take part in a trust fund: the grantor, the trustee and the beneficiary. The grantor is the person who establishes the trust fund and places his or her assets into the fund. The trustee is the person or institution who holds and manages the assets. Finally, your beneficiary is the person you choose to receive the fund’s contents.

The grantor works with a lawyer to create the trust. You can also choose a financial advisor to work with to help you allocate your assets in the best way. The grantor names the trustee, often a family member or a financial institution. A grantor must also name the beneficiary like their children or grandchildren, a business partner or a charity. The grantor and the lawyer also draw up the terms of the trust fund. The terms include which assets the grantor will include and how they want the trust to distribute those assets.

Trust funds differ from other estate planning tools. They enable the grantor to provide specifications for how and when the beneficiary will receive the trust’s assets. For example, as a grantor, you may choose to pay funds annually to the beneficiary or as a lump sum. The grantor can even specify the funds go towards a significant expense. Common examples include college tuition or a down payment on a house.

A common inclusion in a trust fund is a “spendthrift clause.” This prevents a beneficiary from using the trust fund’s assets to pay off their debts. So even if your grandson were to gamble away all his own money and incur a ton of debt, his creditors can’t touch his trust fund. That way, your grandson can still have some backup money to help him get back on his feet.

How to Fund a Trust

Once you establish a trust, you must fund it with the intended assets to serve its purpose. Funding a trust means legally transferring ownership of assets from your personal name to the name of the trust. This process can involve retitling real estate, transferring bank and investment accounts, or assigning ownership rights to personal property.

For real estate, you may need to file a new deed with your local county office. For bank or brokerage accounts, most institutions require trust documentation and completed forms to update ownership. You can also assign ownership of assets like business interests, patents, royalties, or valuable personal property to the trust.

Failing to fund a trust correctly or completely can result in those assets being subject to probate. Or the trust may not distribute them according to your wishes. Regular reviews ensure that new assets acquired after the trust was created are also included. A financial advisor or estate planning attorney can help identify which assets you should place in the trust and complete the transfer process.

Revocable vs. Irrevocable Trust Funds

Trust funds can typically be either revocable or irrevocable, which impacts how they can be updated after their initial creation. Here is how each works.

Irrevocable Trust Funds

Irrevocable trust funds, once established, are unchangeable. As the grantor, you cannot rescind the trust nor change the terms or distribution. This rigidity comes with some benefits.

First, because the grantor no longer owns the assets, they don’t need to pay income tax on money made by these assets. Funds from an irrevocable trust no longer count as part of the grantor’s estate. Therefore, moving assets into an irrevocable trust can also help the grantor move into a lower tax bracket or avoid paying estate tax. Irrevocable trusts also protect funds from legal claims and debts against the grantor. This way, the beneficiary can still benefit from those assets in the event the grantor falls into debt or hardship.

Revocable Trust Funds

Revocable trust funds, also called living trusts, are changeable at any time. You can update them as needed by adding or removing assets and beneficiaries. You can even dissolve the fund which results in returning the assets to the grantor. This allows for more flexibility and control, as the grantor can make changes until their death.

However, unlike an irrevocable fund, the funds within a revocable trust are still part of the grantor’s estate. This leaves them less protected if the grantor faces legal claims, medical bills, or other debts. In this case, the funds in the revocable trust aren’t protected.

What Are the Different Types of Trust Funds?

There are several different types of trust funds that you can choose from, in addition to just choosing between making the trust fund revocable or not. The right one will depend on the purpose of the trust fund, as each benefits a different type of person or entity. Below we cover some of the most frequently used types of trust funds.

• Blind Trust Fund: When your establish a blind trust, the beneficiary of the trust does not know who holds the power of attorney to make decisions for the trust. However, this is typically the trustee. These trusts are typically used to create a layer of separation and to eliminate any potential conflict of interest.
• Land Trust: This type of trust exists to manage real property. If land or physical property is being passed from one generation to the next, then a land trust fund could help facilitate that transfer and give the power of management to the trust itself.
• Charitable Remainder Trust: A charitable remainder trust, also called a charitable annuity trust, allows you to pass on your assets to a specified charity instead of a relative. The assets within this kind of fund provide income for the beneficiary during the life of the trust. When you fund a charitable remainder trust, you can immediately benefit from charitable-contribution tax credits. Plus, you’re donating your assets toward a great cause.
• Marital Trust: A marital trust fund, also known as a marital deduction trust or A trust, is an estate planning tool designed to provide for a surviving spouse while taking advantage of tax benefits. This type of trust allows the assets to pass to the surviving spouse without incurring estate taxes, due to the unlimited marital deduction available under tax law.

The Cost of Setting Up and Maintaining a Trust

Trust funds are genuinely available to people across a range of net worths. However, the costs involved deserve a clear-eyed look before committing to one. Those costs vary depending on the type of trust, how complex the terms are and who manages it.

Attorney fees for drafting a trust typically run from a few hundred dollars for a straightforward revocable living trust prepared by a general estate planning attorney to several thousand dollars for a more complex irrevocable arrangement with detailed distribution conditions. Geographic location affects pricing significantly, as does the attorney’s experience with trust and estate work. Online legal services offer lower-cost templates, but a trust document that isn’t tailored to your state’s requirements or your specific circumstances can create problems that cost far more to fix than the original drafting would have.

Example

If you name an institutional trustee, such as a bank or trust company, to manage the trust rather than a family member, expect to pay an annual fee typically ranging from 1% to 2% of the assets under management. ¹ On a $500,000 trust, that’s $5,000 to $10,000 per year, every year the trust remains active. Family members serving as trustees don’t charge fees in most cases, but they take on legal responsibilities that require time, record-keeping and sometimes professional guidance to fulfill correctly.

There are also ongoing administrative costs to account for. Trusts with income-producing assets need annual tax filings. Real estate held in a trust requires continued management. Any time the terms need to be interpreted or a distribution is disputed, legal fees can add up quickly. For an estate with modest assets and straightforward wishes, a well-drafted will combined with updated beneficiary designations on financial accounts may accomplish similar goals at a fraction of the cost. A trust earns its price when the estate is complex, the distribution conditions are specific or avoiding probate and maintaining privacy are genuine priorities.

What Happens When a Trust Is Poorly Drafted or Not Funded

A trust that exists on paper but never received proper funding is one of the most common estate planning failures. The document itself has no effect on assets until you transfer them into the trust. A house or brokerage account that remained titled in the grantor’s name will pass through probate at death regardless of what the trust says. The trust document becomes a statement of intent with no legal force over these assets.

Funding a trust requires action beyond signing the document. Real estate needs a new deed filed with the county naming the trust as owner. You must retitle financial accounts through the institution, which typically requires trust documentation and completed transfer forms. Each of these steps requires follow-through after the attorney meeting, and many people stop at the signing without completing the transfers.

Drafting problems create a different category of failure. Trust language that seems clear to the grantor may produce genuine disagreement among beneficiaries and trustees. A trust drafted decades ago and never updated may reflect a family situation, tax liability or an asset mix that no longer exists. Reviewing the document every few years and after any significant life change keeps it aligned with current circumstances and current law.

Beneficiaries named in a trust often know little about what it contains until the grantor dies. That gap creates confusion, delays and sometimes conflict at an already difficult time. Sharing the basic terms with beneficiaries during the grantor’s lifetime, what assets the trust holds, when and how it will make distributions, and who the trustee is, removes most of those complications before they develop. It also gives the trustee and beneficiaries a chance to ask questions while the person who created the trust is still available to answer them.

Who Needs a Trust Fund?

You’ll find trust funds useful if you want to leave money, property or other assets to someone else and ensure their use in a specific or incontestable way. You can set up a trust to pay out assets at specific times, such as annually, for specific events like graduation or at a certain age. If you want to make sure your wealth lasts longer, you can choose to have it paid out to your beneficiaries in installments rather than a lump sum. If you want to pay for your grandchildren’s education, you can have it paid out for their tuition only.

Trust funds also combat some of the issues you might face with a will. Unlike a will, trusts are not subject to probate, the legal process that verifies your will. Since the assets in the trust belong to the trust, not the grantor, there’s no need to transfer ownership of those assets upon the grantor’s death. Without probate, trusts also keep your estate dealings private.

Bottom Line

A trust fund is a solid estate planning tool for those who want more control over their assets than what a will can provide. Trusts allow the grantor (the person setting up the trust) to define its terms. This principally includes how and when you want the contents of the trust to go to your beneficiaries. Irrevocable trust funds also provide some tax benefits and protection of their assets from legal action.

Estate Planning Tips

• Determining whether a trust fund is needed, or which type you want to create, can be a difficult decision and you shouldn’t have to go about it alone. A financial advisor can help you determine the right step forward for your situation. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• If you’re planning on leaving a large pool of funds to your family following your death, you’ll want to plan ahead for the estate tax.
• Trust funds can be an integral part of people’s estate plans. However, you’ll likely need to do much more than that to ensure your family is taken care of after you’re gone. Check out our guide on estate planning vs. wills to learn more.

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