New Investor's Guide to Trust Funds
Using Trust Funds to Build, Protect, and Pass on Wealth
There is a common misconception among new investors that leads to them thinking trust funds are only for the rich. Almost all Americans, especially older retirees, can benefit from using trust funds if they have at least some savings. From tax advantages to protecting your heirs from creditors or even their own poor decisions, there is simply no tool as useful as a well-designed trust.
If you've never been on the receiving end of a trust fund, you may not understand what they are or how they work. Fortunately, a trust is not nearly as scary as many new investors seem to think. Even if you only have some small savings, it can be one of the most efficient ways of protecting, passing on, and nurturing wealth. This overview explains the basics—who the grantor, beneficiary, and trustee are, how a trust is structured, and more.
If you have ever wanted to set up a trust fund for your family members or other heirs, here is a basic overview of the process to help you understand what you might expect.
It may come as a surprise, but the process of naming your family trust fund is an important one. Many trust fund grantors use some derivation of their name but it can be advantageous, particularly for privacy reasons, to name a trust after things that can never be tied back to your family, helping you protect your assets from prying eyes.
Sometimes, new investors have a misconception that investing money held in a trust is different than running an ordinary portfolio. In most of the important regards, it isn't true. The trust will likely have a mandate restriction on it, spelling out the types of securities the portfolio manager can acquire and under what conditions, but the nuts and bolts of administering the funds aren't really a radical departure from any privately overseen pool of capital.
There are two broad categories of trust funds—Testamentary trust funds and living trust funds, the latter of which are also known as inter vivos trust funds. Though they may sound complex, it's really very simple. They differ in how they are created, but otherwise, can take advantage of practically all of the same benefits, and suffer from nearly all of the same drawbacks. Take a few moments to learn the difference between the two and how each is formed.
For all of their advantages, trust funds do have some significant drawbacks of which you need to be aware. Here are some of the biggest that could cause you or your beneficiaries problems later down the line. A small amount of planning, and a little bit of defense now, can save you enormous tax liabilities, legal troubles, and inter-family fighting in the future.
If you are using a trust fund to pass on wealth to your children, grandchildren, other heirs, or even favorite charity, whom you choose as a trustee will have a very powerful influence on the ultimate fate of the money. Here are three questions you should ask yourself before you vest someone with the authority to act as the trustee.
Using Charitable Remainder Trusts to Pass on Wealth and Give to Charity
Did you know you can use a charitable remainder trust to generate income for your beneficiaries and, later, effect a large, tax-advantaged gift to charity, or even multiple charities of your choice? It's easy thanks to something known as a charitable remainder trust. This special type of trust fund isn't as complicated as it seems once you understand the basics. It can be a magnificent estate planning tool, or as a way to benefit friends and family while doing good in the world.
You probably love your heirs. Still, some of them make more mistakes than others. Are you worried about your beneficiary developing a gambling, drug, or spending problem? Getting divorced? Being pursued by creditors? One way you can help protect the money you leave them is to include a special provision that transforms a regular trust fund into a spendthrift trust fund. This prevents them from being able to pledge, or transfer, the trust principal, and only entitles them to the stream of money coming out of the trust, which the trustee can shut off if the beneficiary is threatened.
Using Trust Funds to Protect and Generate Substantial Wealth
If you want your children, grandchildren, and great-grandchildren to enjoy the fruits of your labor, receiving distribution checks from stocks, bonds, real estate and private businesses that you shrewdly, and in some cases, lovingly, amassed throughout your lifetime, the best way to do it is often a trust fund. This overview of using trust funds as a tool for multi-generational planning was designed to help provide a glimpse of why so many successful people turn to trusts when they want to provide for, and protect, their heirs.
Trust Funds Aren't Just for the Rockefellers
You do not have to be super rich to enjoy the benefits of trust funds. Even if you have only $10,000 or $25,000, a trust fund might be the perfect way to protect your heirs from themselves, as well as creditors, ex-spouses, gambling addictions, and bad money habits. With nominal administration costs, almost all banks have trust departments that can handle simple portfolios once you've passed away or decided to make an irrevocable gift to the trust, often for less than 1% to 1.5% per annum. Though that may seem expensive relative to some other investment vehicles, the protections are well worth the cost when you realize the money is put beyond the reach of those who inherit it so they can only spend the income, not the principal, if that is what you desire.
If you amass assets during your lifetime and want to provide for your children and grandchildren, you might need the services of a bank trust department at some point. How do they work? How are they paid? Learn the answers to these questions and more.
Once you begin dealing with trust funds, you are going to encounter something known as the prudent man rule, also known as the prudent investor rule. It's an important concept so take a few minutes to discover what it means and why it matters so much.
Along with a bank trust department, a registered investment advisor is one of the more popular ways to outsource the job of managing the capital meant to be preserved within a trust fund. This is an introduction to RIAs that is worth your time.