Many people associate trust funds with rich 20-somethings posting photos on a yacht in Italy. But a trust fund can be an excellent estate-planning tool for families of modest means as well, says estate-planning attorney Michael Gilfix, Esq. According to data from the Federal Reserve, the median size of a trust fund now is around $285,000.
What is a trust fund?
Trusts are legal entities that hold and manage assets for the benefit of others. A trust fund allows you to make sure the money and assets you’ve earmarked for your heirs, typically your children and/or grandchildren, are there for them. A trust fund allows you to fine-tune inheritance decisions based on your values, as well as transfer and protect family wealth after your death.
Bottom Line Personal asked Gilfix how trust funds can be useful even if you don’t have millions of dollars…
Why You Need a Trust Fund
Trust funds allow you to control the money and assets in the fund for the benefit of an heir without legally holding title to those assets. In many circumstances, this provides three major advantages…
You can dictate how trust assets are managed and distributed, when you are alive…and after your death. This allows parents to create a detailed, long-term vision of when beneficiaries receive money from the trust fund, the amount and under what conditions more effectively than just leaving an inheritance directly to them. Example: You think your child might squander a large inheritance, so you stipulate that she receive half of the assets in the trust at age 30 and the other half at age 40, presumably when she is more financially mature. Or you might decide that the trust fund will pay only for certain expenses that you deem important such as health care or a college education.
Trust fund assets avoid probate when you die, unlike assets you leave in your will. Probate is a state-mandated legal process overseen by a court to validate a deceased person’s will and ensure proper distribution to creditors and beneficiaries. Even with modest estates, probate can be long and stressful for surviving family members. First, it is public, so anyone can access the details of your will or file a petition to challenge the will. Second, probate can be very costly. In California, state law sets the legal fees for probate. That fee is $23,000 for a $1 million estate, not counting the executor fee, which is also $23,000. But if your assets are in a trust fund, it allows for inheritance after your death with significantly fewer delays. The contents of the trust fund are private, and challenging a trust in court is rare because it’s very costly to do.
Trust assets are protected after your death. Money left to children in a properly drafted trust fund typically is shielded from their potential creditors, including banks and credit card companies, bankruptcies, lawsuits and other legal claims including a child’s divorce proceedings.
How to Set Up a Trust
You are not required to have an estate-planning attorney set up a trust fund, but since trusts are governed by complex laws that can vary from state to state, it is a good idea to have one. Even small errors in drafting or failing to properly fund the trust can lead to legal challenges. An attorney can also help you shape the terms of the trust. Where to find a trust attorney: You may be able to use the same attorney who prepared your will, or you can consult The American College of Trust and Estate Counsels (ACTEC.org). Typical cost to create a basic trust fund: $5,000 to $10,000.
Understand the language of trust funds
Must-know vocabulary…
Grantor is the person who creates the trust fund and puts assets into it.
Beneficiaries are individuals who receive the income or assets from the trust fund.
Trust assets are money and other valuables held in a trust fund. These can range from cash, stocks and bonds to real estate, life insurance policies and shares in a private business.
Trustee is the individual appointed by the grantor to administer the trust fund…manages its assets…distribute net income and/or principal at times specified by the trust agreement…prepare periodic accountings of the trust’s transactions for beneficiaries…and files trust income tax returns.
Decide if your trust fund is living or testamentary
A living trust takes effect during your lifetime. Assets are transferred into the trust while you are still alive and distributed depending on the terms of the trust. You typically can serve as trustee of your living trust. The person you name as your “successor” trustee takes over if you become incapacitated or upon your death. Living trusts avoid probate.
A testamentary trust is created through your will and goes into effect only after your death. Although testamentary trusts are subject to probate, they provide helpful mechanisms for families with young children, grandchildren and/or family members with disabilities.
Determine if the trust fund is revocable or irrevocable
Revocable trust funds can be amended during the grantor’s lifetime, so you have the ability to address changes in your circumstances or the lives of your beneficiaries. You can name yourself trustee and continue to use or sell the assets in the trust fund as you see fit. You also retain the power to revoke the trust fund entirely or change the terms including the beneficiaries. Any income generated by a revocable trust is taxable to you—the grantor. One disadvantage: Assets in revocable trusts are not protected from creditors and legal judgements against you.
An irrevocable trust fund typically cannot be modified or terminated, so it requires advanced planning to ensure your vision is firm from the outset. Most irrevocable trust funds must file a tax return and are responsible for tax on any undistributed income that’s generated. The assets in an irrevocable trust fund are shielded from creditors and legal judgments if appropriately drafted.
Common and popular strategy: Many parents establish a living revocable trust fund, which allows you to easily make modifications while you are alive. When you pass away, the trust fund becomes irrevocable and the successor trustee takes over.
Caveats When You Create a Trust Fund
Your choice of trustee is critical
Selecting an unqualified trustee or someone who lacks impartiality despite good intentions can jeopardize your beneficiaries’ futures. Take the following steps…
Ask yourself, Does the individual have the time and financial acumen necessary? Does he/she have any potential conflicts of interest? Many grantors feel more comfortable tapping a close friend or family member as a trustee, but that comes with its own risks. Examples: Putting one sibling in charge of another sibling’s trust fund money can create enormous family tensions…if your trustee is a family friend, he might give in to pressure from beneficiaries and provide early or excessive distributions, undermining your original intentions. Most grantors choose trusted, responsible family members.
Consider appointing a professional trustee or trust company if no friend/family member seems right for the job or if your trust fund is complex and requires overseeing lawyers, accountants and investment advisors. Where to find one: Ask your estate-planning attorney for a recommendation. You can find trustee services at local banks, trust companies and independent fiduciary services.
Most states have associations of professional fiduciaries, and most banks and financial institutions also offer trustee services.
Alternative: Appoint a family member as co-trustee along with a professional trustee. The family member brings intimate knowledge of the beneficiaries, while the professional can provide needed expertise and checks and balances. Cost for a trustee: A family member or friend may charge an hourly fee or even waive fees altogether for simple trusts that require minimal oversight. A professional trustee typically charges anywhere from 0.5% to 2% of the trust’s assets annually.
Leave room for flexibility when you create the trust fund agreement. The trust’s language should not be too restrictive and should allow the trustee some discretion over unforeseen circumstances. Trustees have a fiduciary responsibility to act in the best interest of the beneficiaries while adhering to the instructions of the grantor, but what seems black and white when you first establish a trust can change dramatically over time. Example: One of your beneficiaries might suffer a disability or health-care issue and need to tap assets in the trust at a more accelerated pace. Alternatively, steps may be taken to convert the trust to a Special Needs Trust so assets are protected and eligibility for needs-based government programs can be achieved.
