We’ve all heard of them, but few of us have them. If you ask the average person what a trust fund is, they’ll say it’s something that only rich kids get. In the past that may have been true, but today even the middle class can get trust funds; and in my opinion there’s no better way to ensure your children get a good head start.
The History of Trust Funds
Trusts for the most part, have been around since the Romans and were actually quite well developed in terms of wills, but not so much in the way of living trusts as they’re known today. The idea of a living trust which could be applied while the creator was alive was developed afterwards by more modern lawmakers. By the 12th century, personal trusts came to be with the (now called) settlor being referred to as a “feoffor” and the trustee known as a “feoffee”. The beneficiary of the trust was at the time called the “cestui que use” or “cestui que trust”.
Since land ownership in England was, at the time, based on the feudal system, when an owner of a parcel of land left to fight in the Crusades, he would convey ownership of the land in his absence in order for the land to be properly managed. Feudal dues were paid and received and it was understood that upon the owners return, the land would be given back to him.
Unfortunately, upon return, many of the Crusaders were refused the return of their property and English common law didn’t recognize their claim. As far as the courts were concerned, the land was now owned by the trustee and that trustee was under no obligation to return the land to the original owner. The Crusader would be forced to petition the king and the matter would be handed off to the Lord Chancellor. At that time he could make a decision on the case according to what he determined to be the proper solution and this is how the principle of equity was devised.
The Lord Chancellor would consider the case to be unconscionable and find it abhorrent that the legal owner, or trustee went back on his word. He would find the court in favor of the returning Crusader and over time it became well known that the Court of Chancery would continuously act in this manner. The legal owner was compelled to give the land back to the returning Crusader upon his return and the term “use of land” was developed for use in such agreements. In time, it became what we now refer to as a “trust”.
By the early nineteenth century, antitrust law began to come into effect as industry created monopolies entrusting their shares to a board of trustees for shares of equal value with dividend rights. By doing this, the board of trustees could enforce a monopoly. At the time, trusts were used since companies couldn’t own another company’s stock without special permission from the legislature. Once the restriction was lifted, holding companies were established.
Today, trusts are significant and are arguably one of the most important and innovative measures of the legal system.
Trusts are varied and any property can be held in a trust, be it for personal or commercial reasons. They benefit estate planning, asset protection and in most regions, taxation. Living trusts, which are popular in many sectors, are created while the person is sill living or after death in a will.
The easiest way to think of a trust is to compare it to a corporation where the settlors are compared to investors, but are also the beneficiaries. A big benefit to a trust or trust fund is the ability to partition or shield assets from the trustee, multiple beneficiaries or creditors which makes it bankruptcy remote. It can then be used in pensions, mutual funds or asset security.
The trust fund for a child is basically a relationship where money is held by one party, which is often a lawyer, bank or trustee, for the benefit of the child. The settlor (parents) can transfer property, money or other assets, including stocks, bonds and mutual funds, into the trust which has very specific orders for how and when it can be used by the child.
Often there are parameters set that permit allowances for living, education, spending money and investment.
Since many trusts are irrevocable, you don’t have the ability to dissolve it unless you specifically go with a revocable trust. Once any type of asset is placed in the trust fund, it’s no longer yours. This is a benefit. Since they’re no longer legally yours, you no longer have to pay income tax on any money that’s made from those assets. It’s for the tax breaks, that many people opt to set their children up with trust funds, rather than leaving them money in a different way. It lowers your tax bracket, but also allows your children to access money in a way you permit, often without having to pay any gift or estate tax if the trust fund is properly planned out.
Appointer: The appointer is the individual who is able and authorized to a appoint a new trustee to the trust or remove an existing one.
Appointment: According to the trust law, the appointment has its usual meaning. It can either mean the appointment of a trustee or it can actually have a technical trust law meaning which is either the act of giving an asset from the trust to a beneficiary or the name of the document which gives effect to the appointment. When it’s within the trustee’s right to do such an act, it’s referred to as the “power of appointment”. This power of appointment can be given to someone other than the trustee which can include the protector, the settlor or even the beneficiary.
As Trustee For (ATF): ATF is the legal terminology used to show that an entity is acting as a trustee.
Beneficiary: The beneficiary is any person or entity that receives any form of benefit from the assets in the trust.
In it’s Own Capacity (IIOC): This term means that the trustee is acting on its own accord.
Protector: In some cases a protector is appointed in an express, inter-vivos trust as an indivual or entity who has some control over the trustee such as the right to dismiss the trustee and appoint another in its place. The protector in a trust is a role that’s become highly controversial with many believing it has no place in the law. Since no one doubts the fiduciary responsibility of the trustee, if the protector is also granted fiduciary responsibility then the courts – if requested by the beneficiary – could potentially order the protector to act in favor of the beneficiary and not on his own accord. This would then require the protector to dismiss the trustee which would possibly go against the wishes of the settlor. Since trust law has been in effect for hundreds of years without this recent addition of a protector, it stands to reason that it’s an unnecessary officer of the trust.
Settlor: The settlor is the individual who creates and funds the trust.
Trust Deed: A trust deed is the legal document that defines the parameters of the actual trust and includes the terms and conditions that must be followed as requested by the settlor.
Trust Distribution: The trust distribution is any income or asset that is given to the beneficiary.
Trustee: The person, people or entity that administers and manages the trust. This party is given the highest duty under the law to protect the trust and its assets from loss and to ensure that the settlor’s wishes are adhered to.
How Trust Funds Work
Originally, trust funds were used by high net worth families as an investment tool to hedge their wealth in the event of a financial fallout such as a divorce or failed business venture. It was an option that prevented them from losing everything they worked so hard for. It was also used to prevent children from overspending.
Wealthy parents quickly realized their children had a penchant for spending and when adulthood hit, so did the pain of having to rely on their own incomes. Parents would set up trust funds as a way to help teach their children the value of a dollar, giving them access to limited amounts for certain life events, or a stipend or allowance payable at certain points throughout their lives.
Today, while trust funds are still used for this, they’re also used by middle class families as a way to leave their children an inheritance or help them start a family of their own.
It can help pay for education, a home, a new car, activities or other events. By putting the funds into a trust, it gives them tax breaks they wouldn’t otherwise receive had you simply handed them a check or money order.
So how do you prevent your children from blowing all the money?
By sitting down with an estate expert such as an attorney or someone you trust at your wealth management institution you can effectively mitigate your risk. They’ll take into account what your concerns are, wishes you have and what you want the money or assets to be used for. There are many different types of trusts and they provide many options to the settlor.
The way the assets are distributed is dependent on the type of trust chosen and the conditions that are set out in the trust. Inter-vivos trusts are typical “gifts” which can be accessed while the settlor is alive, but there are also Testamentary trusts which are incorporated into wills and prevent the assets from being accessed until after your death. For spendthrifts the best option is usually an Incentive trust which only permits payouts for various life achievements such as getting a degree in university or buying a home. It can also be set out so that it matches their income. For every penny earned, a penny is paid. With an incentive trust, there are a wide range of regulations that can be set with milestones or benchmarks for each. In the end, trusts are only as good as the values you instill in your children while you’re alive. They aren’t meant as an alternative to teaching them the value of a dollar, but are intended as a method to help ensure they get a head start at life or to prevent them from ending up broke or homeless because of poor life decisions.
Reasons for setting up a trust fund
There are a number of reasons in addition to the ones specified above that make it beneficial to open a trust fund for your children.
As mentioned, a trust fund can provide some protection to spendthrift individuals. If you don’t trust your children to be able to competently manage their money or they suffer from a disability that hinders their ability to work, a trust fund can ensure that they don’t end up broke or homeless and provide a cushion for any falls. It can also be used to pay the living expenses of a disabled child after your death.
Another reason for a trust fund is if you’re concerned that the letter of your intentions won’t be followed after you die. As an example, if you are leaving a piece of property such as a vacation home to two children from your first marriage, you could use a trust fund to ensure the property is handled accordingly and not fought over.
The biggest benefit of leaving a trust fund to your child is that you can maximize estate tax bypasses which allow you to get more money to more generations further down the family tree. This can allow you to leave assets to grandchildren and even great grandchildren you may never meet.
In addition to protecting your children, a trust fund can actually be used to protect others. As an example, let’s say you own a car dealership and are very loyal to your employees, but want your children to receive profits from it. Now, let’s say your child has an addiction to gambling. By placing the company in a trust, you can ensure your child has access to the profits without putting the business or the livelihood of your staff at risk due to his addiction. By having it in the trust fund, you’re placing the responsibility in the hand of the trustee which can oversee the management of the fund and ensure that the business isn’t held accountable for your child’s actions.
Another reason that’s worthy of considering a trust fund is for the transfer of a large sum of money. You could effectively set up a small trust that would be able to buy a life insurance policy on the settlor. When you die, the proceeds from the life insurance policy would go into the trust which would end up funding it. A trust fund that previously sat at zero dollars, could now potentially be worth a hundred thousand or more, depending on how much the life insurance policy was for.
To summarize, a trust fund can be a fantastic way to hedge your investments and your income. It can positively affect your taxation and ensure your wealth grows with each generation. The aforementioned information should not be used in lieu or in addition to the advice of a reputable attorney. It is not intended to provide you with financial or legal advice and the legislation and laws vary based on your geographical location. Please, always consult an attorney or estate planning professional before making financial or legal decisions of this magnitude.