What it means
Three roles are involved. The settlor creates the trust and puts assets into it, the trustee holds and manages the assets, and the beneficiaries receive the benefit.
The trustee is a fiduciary, which means a person or institution with a legal duty to act in the beneficiaries' interests. Trust funds come in two main types.
In a revocable trust, the settlor can change or cancel the arrangement, while in an irrevocable trust the settlor gives up control, which can offer stronger protection from creditors and in some cases tax advantages. The choice depends on the settlor's goals and the law of the country or state.
People use trust funds for many reasons. Examples include providing for children until they reach a certain age, supporting a family member with special needs, avoiding the delays of probate (the court process of settling an estate), and giving to charity.
The trust document can set conditions, such as releasing money for education or at set ages. The word is also used for public funds, such as government trust funds set aside for a particular programme, where money collected for a purpose must be used for that purpose.
In everyday speech, a trust fund child suggests a young person with inherited wealth, which is a popular stereotype and not a technical term. Costs and rules matter.
Trusts can involve legal fees, trustee fees and annual tax filings, and trust income is often taxed at special rates that can be high. Anyone setting one up should take professional advice on structure, tax and the choice of trustee.
Review is important as well. Family circumstances, tax rules and investment markets change, so the trustee and the family should check the arrangement every few years and record any decisions made.
In practice
Real-world examples.
Example
A grandmother places $500,000 in a trust for her two grandchildren. The trustee pays school fees directly and releases the balance when the younger child turns 25.
Example
A business owner sets up an irrevocable trust holding shares in his company so that they pass to his children without going through probate. The trustee votes the shares and pays out dividends according to the deed.
Example
A charity creates a trust fund from a $5,000,000 gift. The trustees may only spend the annual investment income on scholarships, leaving the capital intact for future years.
Formula
Calculation
Net income to beneficiary = Trust assets x Yield - Trustee fee
A trust fund holds $2,000,000 of investments yielding 4% a year, so annual income is 2,000,000 x 0.04 = $80,000. The trustee charges 0.5% of assets, which is 2,000,000 x 0.005 = $10,000.
Net income available to the beneficiary = 80,000 - 10,000 = $70,000, or $5,833 a month. The principal of $2,000,000 stays in the trust, and the trust deed might release it only at a later date, such as when the beneficiary turns 30. The trustee also reports each year on income received, expenses paid and the value of the holdings.Case study
Seen in the real world.
Fairhaven Family Trust is an illustrative, fictional trust fund created with $4,000,000 by a founder who wanted to support her niece's education and her sister's living costs. The trust deed named a professional trustee and set out how income was to be shared.
Each year the trustee paid $60,000 to the sister and kept $40,000 for the niece's future school fees, while the capital was invested for growth. Reports to the family showed the fund's value, income, costs and payments, so everyone could see how it was being handled.
The illustrative lesson is that clear rules prevented disagreements. When the niece reached university, the trustee released $90,000 for tuition under the terms of the deed without needing to negotiate with anyone.
Watch out
Common mistakes.
- Thinking a trust fund is only for the very rich, when trusts are used by many families for planning and protection.
- Assuming the settlor keeps full control after setting up an irrevocable trust, when control passes to the trustee.
- Ignoring running costs and taxes, when fees and tax rates on trust income can reduce the return.
Questions
People also ask.
What is the difference between a trust and a trust fund?
A trust is the legal arrangement, while the trust fund is the money and assets held within it, though people often use the terms interchangeably.
Who controls a trust fund?
The trustee manages it under the trust document, while the beneficiaries have rights to the benefits and the settlor may keep some powers in a revocable trust.
Can a trust fund be changed?
A revocable trust can be changed by the settlor, but an irrevocable trust usually cannot, other than in limited circumstances allowed by the document or the law.
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