Erik Neilson & Brynne Conroy
What is a trust fund? What do terms like ‘revocable trust’, ‘irrevocable trust’, ‘living trust’ and ‘revocable living trust’ mean? Find all your answers here.
The term “trust fund” has become part of common dialect over the years, thanks in large part to the ultra rich who use trusts in order to shelter their money from estate tax. Despite the word’s prolificity, there’s quite a bit of mystery surrounding trust funds and what they actually are, along with who can use them.
Who is involved in a trust fund?
There are three parties concerned in the execution of a trust fund. You will want to carefully consider the individuals or institutions who you assign each benefit and responsibility as you move through the estate planning process.
- Grantor/Settlor: That’s you! You own property and want to bequeath it to someone else. The property you own may include bank accounts, stocks, bonds, real estate, fine art or even a business. If you own something of value, odds are it can be placed within a trust.
- Trustee: The trustee is the person or institution that executes management of the trust. You may have a financial advisor or a financial institution taking care of your properties, in which case you’ll likely have to pay a management fee. However, it’s completely possible to manage your trust on your own, serving as your own trustee, which allows you to eliminate that cost. Your final decision on this matter should be individualized to your own confidence in handling financial matters and the complexity of your assets. While it’s always good to save money, sometimes it’s safer to pay someone to complete a task you don’t know how to handle on your own. You may also want to assign a successor trustee in the event your original trustee dies.
- Beneficiary: This is the individual who will benefit economically from the trust. They don’t have to agree to this financial arrangement, and in some cases they don’t even have to be made aware that the trust fund exists. This person is often a family member or friend. You can set up a trust with multiple beneficiaries if you so choose. The assets in the trust have to be managed in a way that will give beneficiaries economic benefit. You get to lay out how everything will be managed as the settlor through the process of establishing the trust.
Types of Trust Funds
There are a variety of different types of trust funds that can be made, but a major differentiating element is whether it is a revocable trust or irrevocable trust. A revocable trust—also known as a “living trust”—tends to be flexible, allowing the settlor to dissolve the agreement at any time should circumstances change. Irrevocable trusts are another story. Once established, an irrevocable trust’s terms are largely set in stone and can only be changed in very limited circumstances.
What is an irrevocable trust?
Irrevocable trusts tend to be used for two main reasons: Tax planning and creditor protection. If structured correctly, the growth in value of assets transferred to an irrevocable trust, as well as life insurance proceeds on policies owned by the trust, can be exempt from estate tax. To maximize these tax advantages, those with exorbitant assets may want to look into opening a charitable trust. (More abouttrust fund taxes here.)
Irrevocable trusts also protect assets if a creditor comes after you as the grantor. In certain circumstances, those you owe money to wouldn’t be able to touch the assets held within your irrevocable trust.
The gains on any assets within an irrevocable trust will not count as taxable income. That is because once you establish an irrevocable trust, you cannot change it. The assets in the trust will go to the beneficiaries as assigned, and you cannot modify these terms after they have been set. Since you are not benefitting from the monetary gains, it doesn’t count as your income. Because you only have one shot to get this right, enlisting the help of a team of estate plan attorneys isn’t a bad idea.
What is a revocable trust?
Revocable trusts, also known as living trusts or revocable living trusts, are more flexible than irrevocable trusts. You can change the terms and beneficiaries while you’re alive should your financial circumstances or relationships change.
Because they are so flexible, though, there’s not as much protection. As the grantor, you still have the ability to change the terms of the trust to benefit yourself financially while you’re still alive. That means creditors can come after the assets held within your revocable trust fund should you find yourself in debt. It also means that any gains the trust fund incurs over the year will be subject to income tax.
One major reason to open a revocable trust is to avoid the probate process, which happens after you die. If you simply distribute your estate via a last will and testament, which is still a legal document which may contain testamentary trusts still open to probate, it will be public and searchable. Anyone will be able to look up what assets and debts you left behind and who they went to. The time it takes to distribute your estate is also likely to take longer if all you left was a will.
If you had a living trust, though, the assets held within it won’t even have to go through the probate process, making distribution faster and smoother for your beneficiaries. You’ll also be protecting your and their privacy.
Fun fact: After you die, your revocable trust automatically becomes an irrevocable trust. After all, you won’t be able to make any changes to it after you’ve passed away!
At Tomorrow, home of free estate planning tools, we include revocable living trust services in our Tomorrow Plus upgrade. One of the main reasons our users upgrade is because in the unfortunate chance they should pass away before their children are no longer minors, they do not want them to receive their life insurance benefit in one lump sum. They’d rather have their children receive the funds progressively, as 18-year-olds may not be ready to manage a lump sum.
At the end of the day, the best way to determine whether or not your financial situation is right for setting up a trust is to work with an experienced financial advisor. Creating a trust can be a complex matter, and details can vary depending upon state law. The guidance of a trust attorney can be highly beneficial.
Take the right steps, and a trust fund can help to preserve your legacy while also creating a sound financial future for your beneficiaries.
If you don’t have a trust yet, Tomorrow Plus takes trusts to the next level to make sure your vision for your family is fully covered. Most people can complete their trust in less than a half hour.