Planning your estate while you are still alive is a good move towards ensuring the proper distribution of your assets in the event of your demise. It is a way of protecting your beneficiaries and assets while reducing the estate tax and avoiding probate courts in the future.
Setting up a trust fund for your chosen beneficiaries is a great way to ensure that your loved one’s get what they deserve when you pass away.
Although it is viewed by most Americans as a tool for the rich that want to prevent their kids from squandering their inheritance, it can be used by people with moderate incomes, too.
How Do Trust Funds Work?
Trust funds are a type of legal arrangement where an independent entity holds assets and property for the benefit of another person, organization, or group. A trust fund is used in estate planning to hold investments, money, property, businesses, and any other types of assets.
Three parties are required to set up a trust fund, and they include the grantor, the trustee, and the beneficiary.The grantor is the person who establishes the trust fund and puts money, business, stock, and other assets into the trust.
The beneficiary is the person, organization, or group that is intended to benefit from the trust fund as stipulated while the trustee manages the property owned by the trust. The trustee could be an organization, such as a law firm or a bank, or even an individual.
Benefits of a Trust Fund
Having a trust fund comes with various benefits, and some of them include:
• The assets are protected from any creditors that wish to pursue the grantor for debts.
• They eliminate the need to use the expensive and time-consuming probate courts in analyzing and distributing assets should a person die without leaving any instructions.
• They reduce estate and inheritance taxes that apply to an individual’s property and funds when they die. Placing assets in a trust before one dies minimizes the size of an estate, thus reducing or eliminating the estate tax due.
• The trust protects beneficiaries by ensuring someone responsible looks after their assets until they are mature enough to manage them on their own.
• The assets are protected from other people that are not beneficiaries, such as if the children divorce, then their spouse won’t lay claim on the assets. What Happens to Money in a Trust Fund?
Trust funds contain money in bank accounts, stocks, property, businesses, and other investments. These assets stay in the trust until certain conditions are met.
When the time is right and the circumstances allow, the trust funds will be rightfully distributed among the beneficiaries. The money in trust remains intact until the wishes of the grantor are honored when they are mentally incompetent or dead. The funds can be used for living and educational expenses, or be released as a lump sum to the beneficiary upon the death of the grantor.
Can You Withdraw Money From a Trust Fund?
If the grantor’s wishes include the release of funds for living or educational expenses, then that money will be made available when it is required.
However, if you wish to access the funds early, then the trustee must be involved in the discernment of the exact terms of the trust. In the case of a discretionary trust that is backed up by a letter of wishes, then the trustee decides who will get what and when.
Trustees are not blocked from releasing the funds or assets regardless of the terms of the trust. If one needs any funds or assets to be released early, then they can petition the trustees and clearly explain why they need the early release.
You have the right to take the trustees to court if they do not release the money, but when it will be released remains their sole decision. Courts recognize the powers of trustees and hardly interfere with their roles.
How Do Trust Funds Pay Out?
One of the ways that the trust fund is paid out is through the release of all the assets at once. The grantor might stipulate that the beneficiary should receive the pay-out when they reach a certain age or life milestone. An example is when they turn 30 or complete college.
The grantor might also stipulate that the pay-out be made in several large payouts spread over some time. For example, some proceeds of the trust can be used to pay for college, then the rest can be paid out in small lump sums over the next few decades.
How Much Can the Beneficiary Receive?
A beneficiary can receive a certain percentage like say 25% on reaching 25 and a similar amount after every five years. This sort of arrangement is determined by the grantor and deciding to give the money in portions is for the protection of the beneficiary. Receiving a large amount of funds at once can turn out to be a blessing or a curse.
It is not unusual for the beneficiaries to have a difficult time figuring out what to do with the money. This is why many grantors prefer to divide the trust payout into payouts with small increments for the rest of the beneficiary’s lifetime to prevent misappropriation of the funds. This way, the beneficiary is going to treat the trust as a source of income and not a windfall.
In this case, the trustee will have to manage the trust for a longer time and there will be added administrative costs.
If the trust is created early enough, the grantor might probably continue acquiring assets afterward. Many people would want to add more assets to the trust, and this is usually possible depending on the kind of trust they set up.
Trusts are either revocable or irrevocable, and the type chosen by the grantor will determine if they can add assets after its creation. When a trust fund is revocable, then the grantor will most likely still serve as the trustee. They can add assets or sell them at will.
However, in the case of an irrevocable trust, the grantor has to appoint someone else as the trustee to reap the legal benefits that the trust offers.
In this case, you have given up the control and only the trustee can add assets to the trust. There are some limitations as to how you can go about funding your trust, as some assets are less appropriate for funding than others. An example is you cannot transfer your retirement accounts to your trust, but you can personally retain them and name the trust as beneficiary.
Can You Put a Vehicle in Trust?
Transferring a vehicle that you use on a daily basis might cause problems with registration, insurance, and auto loans, too. Another thing that might pose difficulty in funding your trust is life insurance policies.
You might want to add it to keep death benefits from being part of your taxable estate. Doing so means that you must surrender control of the policy, thus placing it in an irrevocable trust.
When you transfer your policy to a trust you already own, then you must outlive it by at least three years, or the benefits will still be included in your taxable income.
Does a Trust Pay Taxes?
Trusts are taxed differently depending on how their structure and the type of fund they are. Any income paid out to the beneficiaries of a trust is usually taxable. However, the distributions from the trust’s principal are not subject to taxes.
Simple trusts distribute all their income to the beneficiaries at least annually, and they are taxed for that amount and not the trust. A trust fund is a distinct legal entity that is taxable depending on whether it is a simple, complex, or grantor trust. Simple and complex trusts pay for their income taxes, while a grantor trust does not. The grantor pays the taxes for the trust’s income.
The other taxes that apply to trusts include the capital gains tax and the inheritance tax. Assets that have gained value when being taken in or out of the trust, then capital gain tax is payable for the profit on the asset.
When the trust ends and the assets are distributed, then inheritance tax is applicable if it is in the first decade from when the trust was established.
Why Is a Trust a Good Idea?
There are many reasons why setting up a trust fund is a good idea. Besides the obvious reasons for ensuring that the assets are properly taken care of and avoiding probate proceedings, here are some other reasons.
Trusts designate the exact beneficiary of an estate. For example, if your children divorce after your death, then it ensures the spouse does not get any money from the trust fund. Your child will remain the sole beneficiary.
The trust sets limits on how old the beneficiaries need to be before accessing the money. Although legally children over 18 can access the money you leave behind, you can revoke this in your trust fund and set any age beyond that as you wish.
A Trust Can Ensure Education and Healthcare
With a trust, the grantor can stipulate how the money should be used. It can be designated to only be used for education, healthcare, or whatever the grantor wishes.
Trusts payouts can be set to be released in intervals to prevent the beneficiaries from squandering the money. One can set the payouts in intervals to make sure that the beneficiaries get time to plan on how to spend the money well.
The grantor can make use of the “spendthrift” clause that prevents the assets in the trust fund from being sued to settle debts. This ensures that they don’t bankrupt themselves by using the trust fund money to pay off any debts.
The grantor can skip a generation and name the grandchildren as the beneficiaries of the trust fund.
