Trust funds are interesting because of the restrictions some people place on them. There's an ongoing argument I find interesting about ruling from beyond the grave....once you gift someone money and are dead, should you tell them exactly how and why they can spend it?
Back in my college days I had several friends that seemed to have access to all the money in the world as they went to school. One friend in particular spent all kinds of money on off roading vehicles and modifications, and that was just one of his expensive hobbies. I was a bit jealous to see him and all the amazing things he purchased and did. Contrast that with my lifestyle of working as many hours a week as I could while going to school full time so I could avoid any debt. I had no idea what a trust fund was at the time, but my friend was a perfect example of a trust fund baby. He had an education trust fund set up as well as some other interesting trust fund stuff going on in his life while I was living off my Ramen Noodles and minimal sleep as I tried to make it through college.
So What is a Trust Fund?
The question of what is a trust fund is one that a lot of people have asked over the years. Generally speaking, a trust fund is something that people associate with the rich or the famous, and particularly with the children of the rich and famous. However, a trust fund is just a financial tool; nothing more and nothing less. Once someone actually investigates how they work, they’re actually quite simple to comprehend.
A trust fund is a method of controlling and administering assets for the benefit of someone who cannot do it for themselves. Often this includes young people and children (hence the derogatory term “trust fund baby”), but it can also include older people who many no longer have the capacity to manage their own funds.
The process begins when the originator, or the original donor, provides the funds for the trust to be started up. Trust fund managers then take over the fund, investing it and growing it so that it becomes even larger. The beneficiary, the person the trust was created for, will be given a certain amount of money from the fund on regular dates to provide for his or her needs. The beneficiary must comply with the rules of the trust fund in order to keep receiving funds, however.
Types of Trust Funds
There are two major kinds of trust funds, and mechanically they’re very similar to one another. The first is called a living trust, and it is created for a beneficiary while the creator is still alive. This is often the sort of fund created for younger children that need to be taken care of, but which cannot be trusted with their own funds just yet. Similarly, these trusts can be created to provide care for older relatives to put them on a steady income. These trusts can be changed, and even dissolved, as long as the person who created it remains alive and maintains power over the trust and its funds.
The second kind of trust is called a testamentary trust, and it is provided through someone’s last will and testament. This kind of trust is permanent, in the sense that the creator can’t cut it off since that individual is already dead. Beneficiaries named will have access to the funds as per the agreement and rules that created it.
Why Create a Trust Fund?
While it might seem like a convenient way to provide help to family members, a trust fund is a tool that comes with a variety of different uses. For instance, many times the funds that go into a trust can avoid being taxed. This is true for funds that would be subject to an inheritance tax, income tax or any other kind of tax. Though taxes will have to be paid when the beneficiary gains access to them, the taxes will be deferred.
Additionally, a trust fund might be created to benefit a certain group of people, an organization or some other collection entirely. So, for individuals who believe strongly in leaving money to a cause, but who want to do it in a way that isn’t just a lump sum payment, a trust fund is one of the solutions to that particular problem.
I don’t hold anything against my friend the trust fund baby, I wish I had an education trust fund set up for me or any type of trust fund for that matter would have been pretty cool.
So how many of you out there living off a trust fund? My guess is none of you, since most people in those types of situations are not the people reading about personal finance since the do not have as much of a need to, it is the rest of us that read this kind of stuff.
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About the Author: KC Beavers is a semi-retired entrepreneur. The subject of personal finance has always fascinated him. In an effort to not bore those around him with all his love of personal finance as much he has come here to bore all of you instead. Be sure to follow KC on Twitter or Google+.
I’m new to the concept of Trust fund. It sounds like ‘here’s your chance to get super-rich’ :) Thanks for the post, it was very educating.
Not all who have trusts are wealthy! The only person I've known for sure to have a trust in the real world was a school teacher. In today's money, the trust yielded about $20k a year. :) So it definitely was NICE and boosted the teacher's salary, but it wasn't life-changing.
I suspect that most trust recipients are the same....
I have some friends from undergrad who were trust fund kids but they had to really adhere to all the rules, otherwise they couldn't pay their rent to live with us. One of the kids had to get drug tested every month to make sure he was following the rules of his trust fund!
Here is the thing, Trust Funds, like you said are one vehicle, which can produce finalized results. They have been around for hundreds of years, and are well understood. Things like 529 account, as well as UGMA/UTMA accounts have been less battle tested, but are starting to gain more mainstream approvals (and court rulings) making them as desirable, as a trust. The point of the trust as you pointed out, was to provide for a person, for a stated period of time, with specific things in mind. A 529 can provide for college, as an UGMA/UTMA account can provide for anything.
So what does this mean? Yes I know people who have had trust funds, and yes many had a lot of money to play with. While a trust fund baby might be a bit harsh in the amount of money they got (as I know several who got like $5k a year for college in the 1990's), there are some with the proverbial silver spoon in their mouth. It all depends on what the original donor created. I am looking into creating a living trust, and not for any other reason than a way to keep assets together and minimize the transfer of ownership upon my ultimate death.