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A trust fund is a financial tool that holds and administers assets for the benefit of another person or organization, called a beneficiary. The initial assets for the fund are provided by a grantor or donor, and a trustee or team of trustees manages the funds according to that person's instructions. The beneficiary receives payment from the fund as a lump sum or in periodic installments, according to the terms of the trust. Trust funds are often used to set aside property, investments, or cash assets to provide for people who are unable to manage their finances for themselves, like children or people who are ill. People can even establish one for themselves, under the assumption that they will become unable to manage their personal finances sometime in the future.
Types of Trusts
There are two main types of trust funds — living and testamentary — that differ mainly in terms of how and when they are set up. The first is established during the lifetime of the grantor and may be revocable, meaning that it's possible to set up the trust in such a way that it can be changed or dissolved by the grantor. The second is set forth in a will, and is always irrevocable, since the grantor is dead and therefore can't change or dissolve the trust.
Funds established to lessen or avoid tax liability usually cannot be changed either. For example, some jurisdictions limit the amount of assets that can be given as a gift without being taxed. People can avoid this limit by establishing an irrevocable trust fund giving the assets to a beneficiary. Though that person will eventually have to pay taxes on the assets when he or she gets paid, this can be deferred for a long time. This strategy is also sometimes used to shield life insurance benefits from estate taxes.
The structure and procedure for establishing a trust fund varies greatly depending on why it was set up. Some are set up so that the trustee can use the assets to benefit the beneficiary, but the beneficiary can't access the funds him or herself. Others can only be used to benefit a designated group, class, or organization. A unit trust is set up in such a way that multiple beneficiaries hold shares in it, and they can then have the trustee pay them according to how many shares they hold. There are many other different types of trust funds as well, and each is structured slightly differently.
Setting Up a Trust Fund
Laws regulating trusts vary by jurisdiction, so anyone wanting to set one up should see a lawyer. With a living trust, all of the assets have to be transferred before the grantor dies or the trust is void, and the assets will be disposed of by the government in accordance with probate laws. Any of the grantor's assets not assigned to the fund can usually only be transferred to it after he or she dies if there is a clause specifying this in the person's will. Testamentary trusts are established after the death of the grantor as specified by the terms of his or her will. In this situation, a probate court will oversee the trustee as he or she manages the fund, and can act as a trustee if one isn't named.
Advantages and Disadvantages
Trusts have many advantages, since they're flexible enough to allow the grantor to tailor one to his or her needs, can be used to defer taxes, and are quite private. They are also generally a safe way to provide for beneficiaries after the grantor is dead and can save them the hassle and fees that are often the result of dealing with the grantor's assets. Despite this, they are not the best choice for every situation. Grantors can get into trouble if they try to use the assets without consulting with the trustees and beneficiaries, and trustees generally charge for their management services, which can be expensive. Also, depending on the set up, the trustee may not have a lot of supervision, and may do a poor job managing the assets.