Setting Up a Trust Fund For Your Child

January 11, 2023

What is a Trust Fund?

A trust fund is an estate planning tool in which a trustee holds and manages assets for the benefit of one or more beneficiaries. The assets in a trust fund can include cash in bank accounts, stocks, bonds, real estate, and other types of investments.

How Trust Funds Work

Estate planning is the process of arranging how an individual’s or family’s assets will be managed and distributed after death. This includes any bank accounts, investments, personal property, real estate, life insurance, artwork and debt.

Trust funds are one legal entity commonly used in estate planning. To establish a trust fund, three parties are involved:

  1. The grantor: The individual who sets up the trust fund and establishes a plan for the management and distribution of their assets.
  2. The beneficiary(s): The person, or people, for whom the assets are managed.
  3. The trustee: The trustee is a neutral third party charged with managing the assets involved. This can be an individual, a trust bank or another professional fiduciary. The trustee is responsible for carrying out the interests of the grantor.

7 Types of Trust Funds

There are many different types of trust funds, each with its own specific purpose and set of rules.

  1. Revocable Trusts: A revocable trust, also known as a living trust, can be modified or revoked by the person who established the trust. This type of trust is often used to avoid probate and to manage assets during a person’s lifetime.
  2. Irrevocable Trusts: An irrevocable trust cannot be modified or revoked once it has been established. This type of trust is often used for estate and tax planning purposes, since assets held in an irrevocable trust are generally not subject to estate or gift taxes.
  3. Testamentary Trusts: A testamentary trust is a trust that is established in a person’s will and takes effect upon their death. This type of trust is often used to provide for minor children or other beneficiaries who are not yet capable of managing assets on their own.
  4. Charitable Trusts: A charitable trust is a trust that is set up for the benefit of one or more charitable organizations. There are different types of charitable trusts, like charitable remainder trusts, charitable lead trusts and private foundations.
  5. Special Needs Trusts: A special needs trust is a trust that is set up for the benefit of a person with special needs, such as a disabled person. This type of trust is used to provide for the beneficiary’s needs without disqualifying them from receiving government benefits.
  6. Life Insurance Trusts: A life insurance trust is a trust that is set up to hold and manage a life insurance policy. The trust is the owner and beneficiary of the policy, and the proceeds are used to provide for the beneficiaries of the trust.
  7. Spendthrift Trusts: A spendthrift trust is a trust that is set up to manage assets for a beneficiary who is unable to manage their own finances, such as someone who has a history of financial mismanagement. The trustee is responsible for managing and disbursing the assets according to the terms of the trust.

These are some examples of the most common types of trusts, there are many more types of trust exist, like qualified personal residence trusts, dynasty trusts, etc. Each trust type can have unique characteristics and rules and should be established with the help of a lawyer or a financial advisor.

Benefits of Trust Funds for Children

Trust funds can provide a number of benefits, depending on the type of trust and the specific terms of the trust agreement. Some of the most common benefits of trust funds include:

  1. Estate and Tax Planning: Trusts can be used for estate and tax planning purposes since assets held in a trust are generally not subject to estate taxes or gift taxes. This can help to preserve the value of an estate for future generations and reduce the overall tax burden on the beneficiaries.
  2. Asset Protection: Trusts can provide a way to protect assets from creditors and legal judgments. For example, an irrevocable trust can be used to protect assets from creditors, while a spendthrift trust can be used to protect assets from the beneficiary’s own poor financial decisions.
  3. Privacy: Trusts can be used to maintain the privacy of the assets and the beneficiaries. Since trusts are not required to be filed with the court and the terms of the trust agreement are private, trust assets can be passed on to beneficiaries without the public scrutiny that can accompany a probate court process.
  4. Control over asset management: Trusts can provide a way for the grantor to exert control over how the assets in the trust are managed and distributed, even after death or incapacity. This can ensure that the assets are used for the intended purpose and the beneficiary’s well-being.
  5. Managing Beneficiaries with Special Needs: A special needs trust can be established to provide for the care and maintenance of a beneficiary with special needs, without disqualifying them from receiving government benefits.
  6. Charitable Giving: Charitable trusts can be used to support a specific charity or charitable organization, providing a way for the grantor to make a significant charitable contribution while also achieving estate and tax planning goals.
  7. Flexibility: Trusts can be designed to meet a wide variety of needs and goals, such as providing income for a beneficiary’s entire lifetime, distributing assets to multiple generations, or directing assets to specific purposes such as education or health care.

It’s important to note that trusts are complex legal arrangements, and it’s crucial to consult with a lawyer or financial advisor when setting up a trust to ensure that it meets your specific needs and goals.

How to Set Up a Trust Fund for a Minor

If you have decided to create a trust for your child, there are typically seven steps:

  1. Specify the purpose of the trust: Determine why you want to create a trust fund and what you want it to accomplish. This will help you choose the type of trust that best suits you and your child.
  2. Choose which type of trust: Decide whether the trust will be revocable or irrevocable. This choice has important implications for the management and control of the trust assets. A revocable trust allows the grantor to modify or terminate the trust, as well as access the trust assets, while an irrevocable trust doesn’t. This means once assets are transferred into an irrevocable trust, the grantor generally can’t access them or make changes.
  3. Choose a trustee: Select a person or institution to act as the trustee of your trust fund. The trustee will be responsible for managing and investing the assets in the trust.
  4. Select assets to fund the trust: Determine what assets you want to transfer into the trust. This might include cash, stocks, real estate, collectibles and other investments.
  5. Draft the trust documents: The trust agreement outlines the terms and conditions of the trust, such as the duties of the trustee, the rights of the beneficiaries, the payout schedule of assets, and how the trust assets will be managed. You can set up a trust for your child to receive it in a lump sum at a specific time, or break it up into increments throughout major milestones in their life.
  6. Legally create the trust: Once the trust documents have been created, you’ll need to formalize the document by signing it and having the appropriate witnesses. Having a third-party notary to verify signatures is often a good idea.
  7. Fund the trust: Transfer the assets selected into the trust. In many cases, this is a simple title change at the bank or investment company. However, for some trusts, you may have to create new accounts or transfer assets in the name of the trust.

Important Considerations for Your Child’s Trust Fund

There is a misconception that trust funds are only for extremely wealthy families, or that trust fund babies are children who will be able to live off their trust funds for their whole lives.

While these ideas are not true, it is best practice to consider some key points to ensure the trust is effective and useful for your child’s life. 

Choose the Right Trustee

Many parents make the error of selecting the wrong trustee, often because they rush into the decision. It may feel easy to choose a close family member, but there are potential issues that can arise if you choose someone simply because they are related to you.

Selecting a custodian and trustee is important, as those are the people who will manage the funds in the case of your death or other extenuating circumstances.

When making the decision, it’s important to consider the trustee’s health, how far away they live, their age and the age they will be when the child is set to gain control of the trust — as well as their overall trustworthiness and basic judgment.

Be Clear About the Goals of the Trust

Failing to specify clear guidelines and intentions for the trust can lead to unintended consequences, such as young adult children accessing funds and spending it recklessly.

Carefully considering the timing and conditions under which your children will receive access to their trust fund is crucial in creating a Trust that will benefit their financial well-being. This includes determining if and when they’ll receive yearly or occasional disbursements, at what age, or if disbursements are defined by completion of certain life milestones such as education or marriage.

Thoroughly thinking about these factors and being intentional about them is essential for creating a useful trust.

Review the Trust Regularly

Reviewing your trust regularly is so important. Many financial professionals recommend reviewing it annually at a minimum.

As your life changes, your estate plan should change with them. Having an outdated plan can be dangerous and even as bad as having no plan at all.

For smart estate planning, consistently review who you’ve selected as trustee, who is included as a beneficiary, whether there have been births or deaths in the family and the overall financial situation of your family.

The Bottom Line

Setting up a trust fund for your children is a responsible and valuable way to attempt to ensure their financial well-being. In fact, assets of minor children should always be held in a trust in order to protect the assets and ensure a secure adulthood for your children.

However, it is important to approach the process with intention and care. Choosing the right trustee, clearly outlining the intentions of the trust, and thoughtfully determining the timing and conditions for access to the funds are all crucial components of creating a successful trust fund for your children.

By taking the time to thoroughly consider these aspects, you can set up a trust fund that will provide your children with the resources they need to thrive financially in the future.

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