Trust Fund

A trust fund is a legal arrangement that allows assets to be held for the benefit of another person or entity. The person who sets up the trust is called the settlor, the person who manages the trust is called the trustee, and the person who receives the assets is called the beneficiary.
EXPLORE FUNDS
What is a Trust Fund?
EXPLORE FUNDS
3 min
10-September-2024

The meaning of a trust fund is a legal agreement that enables a person to put different kinds of assets (like stocks, money, bonds, Certificates of Deposits, real estate, a business, and others) in a specialised account. It is done to benefit an entity, an organisation, or a person. This article covers the fundamentals of trust funds, including their definition, workings, benefits, types, setup process, and more essential details.

What is a trust fund?

A trust fund is a legal entity in which assets or properties are held by a trustee for the benefit of another person or organisation. A trustee is appointed when the trust is established to manage and oversee the assets of the trust. Some common assets managed by the trustee are money, property, stocks, businesses, and other investments. The appointed trustee ensures that these assets are used according to the terms of the trust and for the benefit of the designated beneficiaries.

How does a trust fund work?

A trust fund works to implement the wishes of the grantor. Even when the grantor is alive, the trustee manages the assets under the trust fund. Upon the death of the grantor, the assets can be transferred by the trustee to the beneficiary (provided he/she has attained adulthood) as per the wishes of the grantor. This handover can be done either in lumpsum or through the creation of a regular income stream.

What is the purpose of a trust fund?

A trust fund is a financial tool used to manage assets on behalf of a beneficiary, ensuring that the funds are utilised according to specific instructions set by the grantor. Typically, trust funds are established for purposes such as safeguarding wealth for future generations, providing for educational or medical expenses, or supporting charitable activities. They offer legal protection, tax benefits, and structured distribution of wealth over time. A trustee, who is responsible for managing the trust, ensures that the assets are allocated as per the trust’s terms, ensuring financial security and responsible asset management for the beneficiary.

What are the benefits of trust funds?

Multiple benefits are there in India for registering a trust in India. Some of them are:

  1. There are statutory rights associated with trust funds.
  2. The number of audits is lower.
  3. It is autonomous in nature.
  4. Long-term tax benefits can be enjoyed.
  5. Heirs and successors can enjoy the benefits as they can avoid probate. The probate court processes are time-consuming and emotionally draining. By creating a trust fund, the entire probate process can be avoided.
  6. The appointment of a trustee ensures that the assets within a fund are taken care of well until the beneficiary reaches legal adulthood.
  7. Proper control is executed through trust funds.

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What are the different types of trust funds?

It is worth mentioning that there are several types of trust funds that are included in the category of “Revocable and Irrevocable trusts”. Each type of trust serves a specific purpose and has different rules and benefits. Let’s check out some of the most popular types:

  • Asset protection trust: This type of trust protects the assets of a person from the claims of their creditors. It is an irrevocable trust that cannot be changed or cancelled after creation.
  • Blind trust: In this trust, neither the person who created the trust (the grantor) nor the beneficiaries know how the assets are being managed. The trustee has total control, which helps prevent conflicts of interest.
  • Charitable trust: This trust benefits a charity or the general public. A Charitable Remainder Annuity Trust (CRAT) pays a fixed amount to beneficiaries annually, while a Charitable Remainder Unitrust gives a fixed percentage of the trust's value to beneficiaries during its term and then passes the remaining assets to a charity. The donor gets a charitable deduction.
  • Grantor-retained annuity trust (GRAT): This allows the grantor to transfer any appreciation of assets to beneficiaries. This trust also helps in minimising tax liabilities.
  • Land trust: This trust is used to manage real estate like land or homes.
  • Medicaid trust: This irrevocable trust allows individuals to set aside assets as gifts to beneficiaries while qualifying for long-term care under Medicaid.
  • Qualified personal residence trust (QPRT): This trust allows an individual to move their residence from their estate to the trust to reduce gift tax costs.
  • Qualified terminable interest property (QTIP) trust: Benefits a surviving spouse but allows the grantor to decide what happens to the assets after the spouse's death.
  • Special needs trust: Provides financial support to beneficiaries who receive government benefits without disqualifying them from those benefits. Usually, this trust type is irrevocable.
  • Spendthrift trust: This trust limits the access of beneficiaries to the assets of the trust. The trustee has discretion over how much money to release and when. Such control helps protect the trust’s assets from the creditors of the beneficiaries and poor spending habits.

How to establish a Trust Fund?

To establish a trust fund, 3 parties are needed. They are:

  • Grantor: This entity sets up the trust fund and also includes all the assets in this trust.
  • Beneficiary: This is the entity for whose financial support of benefit this trust has been set up.
  • Trustee: It can be any neutral entity, whether a bank, a professional, a lawyer, or a confidante of the grantor. It is the trustee that manages all the assets of the trust.

A trustee manages a trust fund on behalf of the beneficiary. He/she must act for the benefit of both the beneficiary and the grantor.

Key takeaways

  • The primary purpose of a trust fund is to hold and manage assets for someone else with the help of a neutral third party.
  • Some key parties of a trust fund include the grantor (the person who creates the trust), trustee (the neutral third party who manages the trust's assets and follows its instructions), beneficiary (the person who receives the assets or benefits from the trust)
  • A trust fund is usually of two major types: revocable trust, which can be changed or cancelled by the grantor and irrevocable trust, which cannot be changed or cancelled once it's set up.
  • Be aware that different types of trust funds exist for specific purposes, like protecting assets, benefiting charities, or providing for special needs.

Revocable Trust Funds vs. Irrevocable Trust Funds

A trust fund is a legal entity designed to hold and manage assets on behalf of a beneficiary, with the terms set by the grantor. Trust funds come in two primary forms: revocable and irrevocable. These two types differ in terms of flexibility and control, which impacts how the assets are managed and taxed.

Revocable Trust Fund

A revocable trust fund allows the grantor to retain control over the assets and make changes or revoke the trust at any time. This flexibility is beneficial for adjusting terms as needed, but the assets remain part of the grantor's estate, making them subject to taxes and creditors.

Irrevocable Trust Fund

An irrevocable trust fund, once established, cannot be altered or revoked by the grantor. This setup removes the assets from the grantor’s estate, offering significant tax advantages and protection from creditors. However, the grantor relinquishes control over the trust's assets permanently.

How Do I Start a Trust Fund?

Starting a trust fund involves several key steps. First, you must determine the purpose of the trust, whether it’s for wealth preservation, education, or charitable giving. Next, you will need to choose between a revocable or irrevocable trust, depending on your needs for flexibility and control. Consulting with a financial advisor or solicitor is essential to ensure the structure suits your goals.

After this, you’ll need to appoint a trustee, who will manage the assets, and draft a trust document outlining the terms. The final step involves funding the trust by transferring assets such as money, property, or investments.

Special considerations

When establishing a trust fund, it’s crucial to consider the potential tax implications, especially with irrevocable trusts, which offer tax benefits but require you to relinquish control over the assets. Ensuring the trust’s terms are clear and aligned with your financial goals is vital, as any ambiguity could create future complications for beneficiaries or trustees.

Another important consideration is selecting the right trustee. The trustee’s role involves managing the trust’s assets and ensuring its terms are followed, so choosing someone reliable and financially knowledgeable is essential. Regular reviews of the trust’s terms and performance also help in adapting to changing circumstances.

Summary

A grantor can transfer all or some of his assets (securities, real estate, and others) to a trust fund, which will be managed by a trustee. This is usually done to secure the financial future of a minor, save tax, and avoid probate. When a beneficiary becomes an adult, the trustee will transfer the assets to him/her.

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Frequently asked questions

What is trust fund baby?
If your parents have set up a trust fund in your name, then you’ll be called a trust fund baby. Though it is generally perceived that a trust fund baby is overly privileged, in reality, that’s not always the case. A trust fund provides a baby with financial security. But it doesn’t always mean that the trust fund baby will have a luxurious life.
Do you make money on a trust fund?
Whether a trust fund makes money or not depends on the type of asset that is held within that trust. If the trust holds collectables or real estate, it doesn’t earn any interest. If the trust fund has assets such as CDs (certificates of deposits) or savings accounts, then it will earn interest. If your trust fund makes money from capital gains, dividends, interest, or others, they will be taxable.
What is the difference between a bank and a trust fund?
A bank is a financial institution that accepts funds and other deposits from people and keeps them in their reserves. Banks use the deposits in their reserve to make loans and earn money. However, trust funds, on the other hand, are legal bodies that hold assets on behalf of a person or group. This special arrangement appoints a trustee to manage trust funds on behalf of that group or person. While a bank usually deposits money, a trust fund can include any kind of asset including bank accounts, cash, stocks, real estate properties, business entities, Certificate of Deposits, bonds, and other kinds of investment.
Is a trust fund good?
Yes, a trust fund is good because it helps its beneficiaries or estates be served well in all financial conditions. Any kind of probate can be avoided by the beneficiaries due to the trust fund. In case of special requirements such as educational needs or paying medical bills, the beneficiaries can utilise the dedicated money from the trust fund.
What are the disadvantages of a trust fund?
In India, one of the main disadvantages of trust funds is their irrevocability. Once a trust has been created, it can’t be revoked or changed easily. A trust fund can become a problem in case the circumstances change such as the beneficiary dies or goes through divorce proceedings. As trustees run a trust fund and its assets, there is a loss of control over the assets.
Are trust funds a good idea?

Trust funds are beneficial because they ensure your assets are well-managed until your beneficiaries are mature enough to handle them. They offer control and protection for your assets by allowing your beneficiaries to avoid the lengthy probate process. Additionally, trust funds can specify how the money should be used (such as for healthcare or education) by providing clear guidance on the intended use of the assets.

What type of trust is best?

An irrevocable trust offers strong protection because its terms cannot be modified once they are set up. This means creditors can't easily access the assets within it. Additionally, assets in an irrevocable trust can usually be passed to beneficiaries without being subject to estate taxes. This, again, makes it a good option for protecting and transferring wealth.

How does a trust fund work in India?

In India, a trust fund works by transferring ownership of assets from the settlor (the person creating the trust) to the trust. While the settlor gives up direct ownership, they can still control how the assets are used and distributed through the trust's terms. The beneficiaries of the trust can receive income generated from these assets or access the assets themselves. This depends on the rules set by the settlor.

Are trust funds for the rich?

Trust funds aren't just for the rich and famous. They help anyone who is looking to better manage and protect their assets. Be aware that trust is a legal arrangement where one person, called the trustee, holds and manages property for someone else's benefit, known as the beneficiary. This setup ensures that the property is used according to the wishes of the person who created the trust. In this way, trusts offer security and a better way to manage assets.

What are the differences between revocable and irrevocable trust funds?

A revocable trust allows the grantor to amend or revoke the trust, retaining control over the assets. An irrevocable trust, once established, cannot be altered, offering greater tax benefits and protection from creditors but requiring the grantor to relinquish control over the assets.

Who should consider setting up a trust fund?

Individuals seeking to manage and protect assets for future generations, ensure structured inheritance, or support charitable causes should consider setting up a trust fund. It’s ideal for those desiring tax advantages, wealth preservation, or legally binding instructions on the distribution of their estate.

What types of assets can be placed in a trust fund?

Various assets can be placed in a trust fund, including cash, real estate, stocks, bonds, business interests, and valuable personal items like jewellery or art. These assets are managed by a trustee, who ensures they are used according to the terms of the trust.

What are the benefits of setting up a trust fund?

Trust funds provide benefits such as tax advantages, asset protection, and control over wealth distribution. They also ensure financial security for beneficiaries, safeguard assets from creditors, and enable structured giving for specific purposes, such as education or charity.

How can I start a trust fund?

To start a trust fund, define its purpose, choose between a revocable or irrevocable trust, and appoint a trustee. Draft a trust agreement outlining its terms, and then transfer assets into the trust, ensuring the trustee manages and distributes them according to your instructions.

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