# Understanding Trust Funds: A Guide to How They Work

## What Is a Trust Fund?

A trust fund is an estate planning tool that holds property or assets for a person or an organization. Trust funds are sometimes simply referred to as "trusts." They can hold a variety of assets such as money, real property, stocks, bonds, businesses, or a combination of many types of properties or assets.

Establishing a trust fund involves multiple parties: the grantor, the beneficiary or beneficiaries, and the trustee. Trust funds can have more than one beneficiary. They're managed by the trustee, who has a fiduciary duty to act in the best interests of the grantor and beneficiaries.

Trust funds can take many forms and they can be established with different stipulations. They can be revocable or irrevocable. Some offer tax benefits and financial protections as well as support for those involved.  

### Key Takeaways

*   A trust fund is a legal entity used in estate planning to manage and distribute assets on behalf of beneficiaries, involving parties such as grantors, trustees, and beneficiaries.
*   Trust funds can be categorized as revocable or irrevocable, with each serving different purposes and offering varying levels of control and tax benefits for the grantor.
*   Revocable trusts allow the grantor to alter terms or dissolve the trust at any time, while irrevocable trusts are more rigid but offer protections against estate taxes and creditor claims.
*   Various types of trust funds, such as charitable, asset protection, and special needs trusts, cater to specific needs and circumstances of the grantor and beneficiaries.

![Trust Fund: An estate planning tool that establishes a legal entity to hold property or assets for a person or organization.](https://www.investopedia.com/thmb/F6Zlka-yxTZCqmRfyaJaMyqigWg=/1080x0/filters:no_upscale():max_bytes(150000):strip_icc()/trust-fund-4187592-1-58df0cb75cbc432090ea169f30193611.jpg)

*— Investopedia / Joules Garcia*

## Understanding the Mechanics of Trust Funds

[Estate planning](https://www.investopedia.com/terms/e/estateplanning.asp) involves deciding how a person's assets and property will be managed and distributed after they die. Property can include any bank accounts, investments, personal property, real estate, and/or [life insurance](https://www.investopedia.com/the-best-life-insurance-companies-8763666). Wills are the most common estate planning tool but trust funds are also popular legal entities. [Laws governing trust funds](https://www.investopedia.com/articles/personal-finance/092115/how-set-trust-fund-canada.asp) can vary depending on the country of residency and creation.

The following parties are involved in establishing a trust:

*   The [grantor](https://www.investopedia.com/terms/g/grantor.asp), who sets up the trust and funds it with their assets
*   The beneficiaries, or persons for whom the assets are managed
*   The [trustee](https://www.investopedia.com/terms/t/trustee.asp), a neutral third party such as an individual, a bank, or another professional fiduciary who's charged with managing the trust assets

The grantor generally creates an inheritance arrangement that's carried out after they're no longer mentally competent or alive. As the appointed [fiduciary](https://www.investopedia.com/terms/f/fiduciary.asp), the trustee is responsible for carrying out the interests and wishes of the grantor. This can include paying a [lump sum](https://www.investopedia.com/terms/l/lump-sum-payment.asp), allocating living expenses or educational expenses, such as private school or college tuition, or transferring property to the beneficiaries after death.

Trust funds provide certain benefits and protections for those who create them and their beneficiaries.

*   Irrevocable trusts can protect assets from [creditors](https://www.investopedia.com/terms/c/creditor.asp) in the event they decide to pursue the grantor for unpaid debts.
*   Trusts avoid the need for [probate](https://www.investopedia.com/terms/p/probate.asp) after the grantor's death, which is necessary to distribute a decedent's property when they leave a last will or have no estate plan at all.
*   Irrevocable trust funds can reduce or eliminate the amount of estate taxes owed after the grantor dies.
*   Trusts can be named as the [beneficiary of an individual retirement account (IRA)](https://www.investopedia.com/ask/answers/081815/can-i-put-my-ira-trust.asp) but they'll be subject to accelerated withdrawal requirements and short-circuit [spousal inheritance provisions](https://www.investopedia.com/articles/retirement/06/marriedperks.asp).

## Comparing Revocable and Irrevocable Trust Funds

All trust funds are either revocable or irrevocable. Both are referred to as ["living" trusts](https://www.investopedia.com/terms/l/living-trust.asp) when the grantor creates them during their lifetime. A "testamentary" trust is created after the grantor's death, usually under terms left in a last will. It's irrevocable because the grantor is no longer living to make changes to it.

### Revocable Trust Fund

The grantor can change or dissolve a revocable trust at any time if they choose. Assets funded or placed into a revocable trust can be transferred to any number of designated beneficiaries after the grantor's death or even during their lifetime.

The primary benefit of a revocable trust is that the assets avoid probate after the grantor's death. This leads to the quick distribution of assets to the named beneficiaries. The terms of a revocable trust aren't made public like those of a last will so an estate can be distributed with a high level of privacy.

> **Important**
>
> Grantors can act as their own trustees when they form a revocable trust or they can appoint someone else to the role. They can name a successor trustee to take over management of the revocable trust after their death when the assets are typically distributed to beneficiaries and the revocable trust is dissolved.

### Irrevocable Trust Fund

An [irrevocable trust](https://www.investopedia.com/terms/i/irrevocabletrust.asp) fund is very difficult if not impossible to change or dissolve. Undoing it or its terms typically requires the unanimous consent of all beneficiaries.

This makes them virtually immune to estate taxes and creditor claims. The grantor of a revocable trust can take back assets they've placed into the trust at any time, so they're still considered to personally own them. This isn't the case with an irrevocable trust. The grantor permanently gives up control and ownership of the assets and money placed into the trust, although they set the terms regarding the beneficiaries who will receive them and when.

## Exploring Different Types of Trust Funds

Several types of trust funds are included under the umbrellas of revocable and irrevocable trusts. They often have different rules and stipulations depending on the assets involved and the beneficiaries. A tax or a trust attorney may be your best resource for understanding the intricacies of each of these vehicles. This isn't an exhaustive list.

*   **Asset Protection:** This fund type protects a person's assets from future creditor claims. Only an irrevocable trust can serve this purpose.
*   **Blind:** This trust attempts to remove any hint of conflict of interest. The trust fund's grantor and beneficiaries have no knowledge of how the holdings are managed. The trustee has total control.
*   **Charitable:** A charitable trust fund can benefit a particular charity or the general public. A [Charitable Remainder Annuity Trust (CRAT)](https://www.investopedia.com/terms/c/charitable-remainder-annuity-trust.asp) pays a fixed amount each year. A Charitable Remainder Unitrust passes assets to a specified charity when the fund expires; it gives the donor a charitable deduction and gives a fixed percentage of income to the beneficiary during the life of the trust fund.
*   **Generation-Skipping:** This trust provides tax benefits when the beneficiaries are the grantor’s grandchildren or anyone who's at least 37½ years younger than the grantor.
*   **Grantor Retained Annuity:** A [grantor retained annuity trust (GRAT)](https://www.investopedia.com/terms/g/grat.asp) allows the grantor to transfer any appreciation of assets to beneficiaries to minimize estate taxes.
*   **Individual Retirement Account:** Trustees control IRA distributions rather than the beneficiaries.
*   **Land:** This allows for the management of property, such as land, a home, or another type of real estate.
*   **Marital:** This trust type is [funded at one spouse's death](https://www.investopedia.com/terms/m/marital-trust.asp) and is eligible for the unlimited marital deduction.
*   **Medicaid:** Designed to allow individuals to set aside assets as gifts to their beneficiaries, this irrevocable trust allows the grantor to qualify for long-term care under Medicaid.
*   **Qualified Personal Residence:** An individual can move their residence from their estate to this type of fund to reduce the amount of gift tax incurred.
*   **Qualified Terminable Interest Property:** This trust benefits a surviving spouse but allows the grantor to make decisions after the surviving spouse’s passing. 
*   **Special Needs:** People who receive government benefits are the beneficiaries of this type of trust. It offers financial support without disqualifying them from government benefits. It follows strict rules and must be irrevocable.
*   **Spendthrift:** Beneficiaries' access to assets is limited with this type of trust. Money and assets are released to them incrementally. The trustee is granted discretion as to when to transfer inheritances to them and how much. This safeguards against the beneficiaries' creditors and/or their bad spending habits.

## Important Considerations for Trust Funds

Managing money across generations can be complex when significant wealth is involved. A trust fund can include a surprisingly complex array of options and specifications as a result.

Trust funds aren't just for the ultra-rich, contrary to what some people believe. Anyone can use them regardless of their financial situation. Discuss your needs with a financial or legal professional to find out what kind of fund is well-suited for you.

## Frequently Asked Questions (FAQs)

## What Is a Trust Fund Baby?

A trust fund baby is someone whose parents have set up a trust fund for them. The term is a popular cultural reference that's often used negatively. There's an implication that these beneficiaries are born with silver spoons in their mouths, are overly privileged, and don't have to work to earn a living.

Trust funds can indeed provide beneficiaries with security, but many so-called trust fund babies don't live luxuriously or in high society.

## How Do Trust Funds Work?

A trust fund is a legal entity that holds property and assets, and can provide financial, tax, and legal protections. A grantor sets it up and funds it with money or assets. One or more beneficiaries receive the assets under specified terms. The trustee manages the trust and distributes its assets at a prescribed time.

The trustee is in charge of managing the assets in an irrevocable trust while the grantor is still alive. The trustee can pass the assets on to the beneficiary or beneficiaries per the grantor's instructions after the grantor's death, under the trust terms that the grantor has set.

Grantors often act as trustees of their revocable trusts. They name successor trustees to take over management and dissolution of the trust when they die.

## How Do I Start a Trust Fund?

You'll first have to figure out which type of trust is best suited for you. Then, decide how you'll fund it. Figure out who you want to appoint as your trustee or successor trustee. The final step is to fund the trust.

Be sure a trust fund is the best choice for you, your beneficiary, and your financial situation. Seek legal help to set up the proper documents to be sure the trust will serve the purpose you intend and its terms will be honored by the court.  

## The Bottom Line

Trust funds are essential tools in estate planning, designed to manage and distribute assets based on the grantor’s preferences. They come in two main forms: revocable, which can be altered or dissolved by the grantor, and irrevocable, which offers tax advantages and protection from creditor claims. By circumventing probate, both types ensure a smoother transfer of assets.

Establishing a trust fund tailors [asset management](https://www.investopedia.com/terms/a/assetmanagement.asp) to personal financial goals and obligations. Consulting a qualified legal professional is crucial to understand which trust best serves your financial objectives and to guarantee that all documentation is correctly prepared, safeguarding your intentions and your beneficiaries' interests.

> **Article Sources**
>
> 1.  Cornell Law School Legal Information Institute. "[Trust](https://www.law.cornell.edu/wex/trust)."
>     
> 2.  Internal Revenue Service. "[Publication 590-B Distributions from Individual Retirement Arrangements (IRAs)](https://www.irs.gov/pub/irs-pdf/p590b.pdf)." Pages 11, 14.
>     
> 3.  Cornell Law School Legal Information Institute. "[Irrevocable Trust](https://www.law.cornell.edu/wex/irrevocable_trust)."
>     
> 4.  Justia. "[Testamentary Trusts Under the Law](https://www.justia.com/estate-planning/trusts/testamentary-trusts/)."
>     
> 5.  University of Minnesota Extension. "[Trusts: Definitions, Types and Taxation](https://extension.umn.edu/transfer-and-estate-planning/trusts-definitions-types-and-taxation)."
>     
> 6.  Internal Revenue Service. "[Instructions for Form 5227 Split-Interest Trust Information Return](https://www.irs.gov/pub/irs-pdf/i5227.pdf)." Page 2.
>     
> 7.  Journal of Accountancy. "[The Generation-Skipping Transfer Tax: A Quick Guide](https://www.journalofaccountancy.com/issues/2009/oct/20091804.html)."