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What Is A Trust Fund And Who Needs One?

7-Minute Read
Published on May 3, 2021
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There’s more to a trust fund than meets the eye. Many think of them as tools for wealthy individuals, but they can be valuable protection for anyone’s beneficiaries. If you want to protect vulnerable family members or young children long after you’re gone, a trust fund might be the right choice.    

What’s A Trust Fund?

A trust is a legal entity that holds assets given to it by one person (grantor) to benefit another person (beneficiary). The grantor or beneficiary can be individuals, a group of people, or an organization. When the trust is funded, it is often referred to as a trust fund.

Although many associate the elite with trusts (“trust fund baby”), anyone should consider the benefits of setting up a trust fund. It helps protect your family members or loved ones from stress, like probate court, and provides for them.

Who Needs A Trust Fund?

You may want to transfer large sums of wealth or pass on assets while avoiding certain taxes. Some trusts, called irrevocable trusts, are created for this purpose. IRS regulations strictly govern them.

Instead, this article discusses trusts with other goals, such as providing for your child or a charity you love. In these cases, a revocable trust works better.

How Does A Trust Fund Work?

Once the grantor sets up the trust fund, they can transfer their assets to it. It can then shelter those assets.

What Assets Can I Transfer To The Trust?

Assets include various items, accounts and property. Grantors can transfer cash, liquid assets like stocks and fund balances, and personal property, like jewelry, into the trust. If a grantor wants to include real estate with the assets, they’ll have to change the title to reflect the trust’s ownership of the property.

What Can The Trust Do With The Assets The Trust Now Owns?

The grantor can do whatever they want with any assets transferred to a revocable, or living, trust. They can even continue to use or change assets up until their death or incapacitation. However, once the trust is out of the grantor’s control, like with an irrevocable, the trust must follow its established document.

Why Is A Trust Fund Better Than An Outright Gift Or Bequest?

While a gift may seem more generous than a trust, it comes with taxes and costs that can outweigh a gift’s benefit. A trust fund’s expenses depend on its purpose and the tax brackets of both the grantor and beneficiaries.

A Trust Fund Offers A Layer Of Protection Between The Grantor And The Beneficiary

With a trust, there is a trustee. This third-party individual has a fiduciary duty to carry out the trust’s purpose. Through this, the trustee can ensure the beneficiary is cared for if the grantor no longer can. The trustee also streamlines the transfer of assets to the beneficiary after the grantor dies.

Large Gifts, Like Real Estate, Can Have Negative Tax Consequences For The Beneficiary

In contrast to a gift, inherited property allows beneficiaries to enjoy a step up in basis when they sell the asset and earn a profit. That helps them minimize the capital gains tax applied.

Grantors Lose Control Of The Asset During Their Lifetimes If They Gift It

Lifetime gifts come with a considerable risk – the grantor loses control over any assets given away. Although, sometimes, there are ways to structure a gift and maintain some access.

What Are The Types Of Trust Funds Available?

There are innumerable terms used to describe a trust. An attorney tailors each one to meet their client’s needs. So, any type can be altered, whether they’re irrevocable or revocable, otherwise known as living trusts.

Although, if the goal is to avoid taxes, you must comply with IRS regulations.

What Is An Irrevocable Trust?

An irrevocable trust cannot be changed or altered by the grantor after it’s established and funded. It also cannot be revoked after their death. Typically, an individual considers establishing an irrevocable trust as part of their estate plan or to transfer large amounts of wealth.

However, you may not obtain tax benefits on it. Typically, the IRS will only give tax benefits to grantors who lose control of their property after making the trust.

How Is A Revocable Trust Different?

The crucial difference between a revocable and irrevocable trust is whether the grantor can exert any control over the trust once it’s established. With a revocable trust, the grantor can change, update or cancel it. Outside of tax avoidance, grantors can still use the assets to achieve their goals without giving up control over the property. In fact, if this is possible, most prefer to retain authority over their trust.

What Purposes Can A Trust Fund Serve?

While you can research the types of trusts out there, they are flexible. Your attorney can completely customize your trust to fit your needs. So, it’s more important to understand what purpose you want your trust to serve.

Once you have an idea in mind, speak to your attorney. You should run any specific questions you have by them. That way, you ensure your planned trust fits in perfectly with your unique circumstances. With that in mind, here are a sample of commonly used trust types.

Special Needs Trust

If you’re a parent of a child with disabilities, you’ll want to make sure they’re taken care of after you pass. A special needs trust provides financially for a disabled child, whether young or an adult, in a way that won’t disqualify the child from receiving government benefits. However, be aware: the trust has to be structured so that its proceeds aren’t used in any way that violates rules for Social Security insurance and Medicaid benefits.

As long as the funds aren’t direct cash payments to the disabled individual, or used for food and shelter, they can cover supplementary needs. This can include things like transportation or home care.

Spendthrift Trust

Some parents may be concerned about their children’s spending habits. They worry the child will misuse their finances, particularly if it’s a large sum of money.

For example, the child exhibited substance abuse issues in the past. The parent of said person might prefer to leave their estate in a trust that limits funds. It only provides enough to cover basic expenses.

Another instance might be where the parent creates a trust that allows the child to have an income up to a certain age. The hope is that they’re mature enough at that point and can then have access to the trust’s assets.

Generation-Skipping Trust

This trust bypasses the grantor’s child and instead passes them on to the grantor’s grandchild. One reason to choose a generation-skipping trust is for tax planning purposes. Others may use this trust to cut their child out of their inheritance while still providing for their grandchildren. The assets can support the grandchildren if the parents are negligent or cover large future expenses, like college.

Charitable Trust

You may want to provide income for your child long-term but also support your favorite organization. A charitable trust breaks up into a charitable lead trust and charitable remainder trust. The former donates a set amount to a charity, leaving the rest to the beneficiaries, whereas the latter uses the opposite route. 

How Can I Set Up A Trust Fund?

Once you know the type of trust you need, you’ll want to set it up. But, trust laws depend on the state the grantor lives in as well as the property’s location. So, the process will vary.

Meet With An Attorney Who Specializes In Trusts

Meet with an attorney who specializes in estate planning or elder/senior law. They can help you create a trust. Meeting them comes with a hefty price, though. Setting up a trust can be costly, and the bulk of that costs is legal fees. There may also be other associated costs with creating a trust, such as administrative costs. These fees will vary by state.

Appoint A Trustee

The trustee manages any assets placed into the trust. Unlike an executor, their job lasts until the funds are gone. The trust may also lay out additional responsibilities. If the grantor is healthy, they can act as trustee, typically to a revocable trust. However, they should appoint a co-trustee in case they, the grantor, pass away or becomes incapacitated.

Transfer Your Assets To The Trust

Once the trust is established, the grantor can simply transfer their assets to the trust. But, in the case of real estate, the grantor has to change the title of the property per the ownership change.

Trusts And Real Estate: FAQs

Rocket Companies® are uniquely focused on the point where finances and real estate meet. Here is some basic knowledge you’ll need to know about trusts and real estate.

Remember: in the case of a special needs trust, money can’t be used for housing without jeopardizing the child’s Medicaid and SSI benefits.

Can Trusts Buy Real Estate?

A trust is only limited by its grantor’s terms. A grantor can decide at any point to fund and direct a trust to buy a house. They can allow a beneficiary to live there and bestow the property to them after they, the grantor, dies. The grantor can also change their position at any time until they’re incapacitated or deceased.

Can The Trust Be Used To Secure A Mortgage?

If you intend to use a trust fund as part of your income as a mortgage applicant, you’ll have to provide documentation. Lenders will take into account the status of the trust and whether the income is discretionary. If it is, the grantor can change the trust’s terms and thus the income. Your lender wants to make sure your income will continue long-term. So, they may accept the trust funds as income, but they have to meet a loan minimum and be a stable source of money.

Can A Trust Lend Me Money To Buy Real Estate?

It depends on the terms of the trust. As long as the grantor allows it, there’s no reason that the trust can’t make the loan.

Can A Trust Co-Sign My Mortgage Application?

If the grantor agrees to it, they can allow the trust to co-sign, or guarantee, a mortgage loan. However, this only applies to revocable trusts. Irrevocable trusts cannot guarantee a loan.

Can I Use A Trust As Collateral For A Mortgage Loan?

If the trust documents stipulate that you can or allow it, an irrevocable trust’s assets can be used as collateral for a loan to the trust’s beneficiary.

The Bottom Line: Trust Funds Give Grantors Peace Of Mind 

Trust funds are a valuable resource that allows you to safe-keep assets for your beneficiaries. Most of all, grantors can ensure their loved ones are cared for when they’re not there. You can learn more about living, or specialized, trusts in our Learning Center.

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Ashley Kilroy

Ashley Kilroy is an experienced financial writer. In addition to being a contributing writer at Rocket Homes, she writes for solo entrepreneurs as well as for Fortune 500 companies. Ashley is a finance graduate of the University of Cincinnati. When she isn’t helping people understand their finances, you may find Ashley cage diving with great whites or on safari in South Africa.