Free Guide to Understanding Trust Funds for Beginners

What Is a Trust Fund and How Does It Work?

A trust fund is a legal arrangement where one person (called the grantor or settlor) puts money or property into a trust to be managed for the benefit of another person or group of people (called beneficiaries). Think of it as a box that holds assets—money, real estate, investments, or valuables—that are managed according to specific instructions.

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The person who manages the trust fund is called a trustee. The trustee has a legal duty to follow the instructions written in the trust document and to act in the best interest of the beneficiaries. For example, a parent might create a trust fund for their child's education. The trustee would manage the money and distribute it to pay for college tuition according to the parent's written wishes.

Trust funds operate outside of a person's will. This means that if you create a trust fund during your lifetime, the assets in that trust pass directly to beneficiaries when you die—they do not go through the probate process (the legal process where a court oversees the distribution of a person's assets after death). This can save time and money for families.

The basic structure involves three main roles: the grantor creates the trust and funds it with assets; the trustee manages the trust according to the grantor's instructions; and the beneficiary receives the benefits of the trust. In some cases, one person can fill multiple roles. For instance, a parent might be both the grantor and trustee, with their children as beneficiaries.

Trust funds can hold almost any type of asset: cash, stocks, bonds, real estate, art, jewelry, or a business. The trustee invests and manages these assets according to the trust document's instructions. Some trust funds distribute money immediately, while others hold assets and distribute them over time or when certain conditions are met (such as when a child turns 21 or graduates from college).

Takeaway: A trust fund is a legal container for assets managed by a trustee for the benefit of named individuals, offering a way to pass assets to beneficiaries outside of the probate process while following specific instructions.

Types of Trust Funds You Should Know About

There are many different types of trust funds, and understanding the main categories helps you recognize which type might be relevant to your situation. The two broadest categories are revocable trusts and irrevocable trusts, which differ in whether the grantor can change or cancel the trust after it is created.

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Revocable Living Trusts: A revocable trust is one that the grantor can change, modify, or cancel during their lifetime. This type of trust is often used for estate planning because it allows flexibility. If circumstances change—such as a divorce, a new child, or different financial goals—the grantor can update the trust document. The grantor typically names themselves as the initial trustee, meaning they control and manage the assets during their lifetime. When the grantor dies or becomes unable to manage their affairs, a successor trustee (named in the trust document) takes over. A revocable trust helps avoid probate and keeps financial details private, since trusts do not become public records like wills do.

Irrevocable Trusts: An irrevocable trust cannot be changed or canceled once it is established, except under very limited circumstances. Because the grantor gives up control of the assets, irrevocable trusts are sometimes used for tax planning or to protect assets from creditors. For example, a person might place life insurance proceeds into an irrevocable trust to keep those assets out of their taxable estate. Once assets are placed in an irrevocable trust, the grantor no longer owns them, which has both advantages and disadvantages.

Testamentary Trusts: A testamentary trust is created through a person's will and only comes into existence after the person dies. These trusts are often used to manage assets for minor children or to provide for a spouse. Because a testamentary trust is created through a will, the assets must still go through probate before the trust is established.

Special Purpose Trusts: Several other types of trusts serve specific purposes. A spendthrift trust protects beneficiaries from their own poor financial decisions by controlling how and when distributions are made. A special needs trust helps provide for a person with disabilities without making them ineligible for certain government assistance programs. A charitable trust allows a grantor to donate to charity while receiving tax benefits or ongoing income. A bypass trust (also called a credit shelter trust) is used by married couples to reduce estate taxes.

Each type of trust has different rules, tax consequences, and purposes. The right type depends on individual circumstances, family goals, and financial situations.

Takeaway: Trust funds come in many varieties—revocable trusts offer flexibility, irrevocable trusts offer protection and tax benefits, and special purpose trusts address specific family or charitable goals.

How Trust Funds Are Created and Funded

Creating a trust fund involves legal steps that establish the trust as a separate entity and transfer assets into it. The process begins with deciding what type of trust fits your goals and working with an estate planning attorney to draft the trust document. The trust document is a legal agreement that spells out every detail: who the trustee is, who the beneficiaries are, how assets should be managed, when distributions should happen, and what happens if circumstances change.

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The trust document must be signed by the grantor, and depending on the state, it may need to be notarized. Unlike a will, a trust document does not usually need to be filed with a court—it remains a private document. However, some states have specific rules about trusts, so an attorney familiar with your state's laws is important.

After the trust document is created, the grantor must transfer assets into the trust. This step is crucial: a trust can only hold and protect assets that are actually placed into it. Transferring assets is called "funding the trust." For real estate, this involves preparing a new deed that transfers the property into the trust's name. For bank accounts, it means opening new accounts in the trust's name or retitling existing accounts. For investment accounts, stocks, or bonds, the grantor or their broker changes the registration to show the trust as the owner.

Some assets are difficult or unnecessary to place into a trust, such as retirement accounts (which have their own beneficiary designations) or vehicles (which may have special titling rules). An attorney can advise on which assets should be transferred into the trust.

The grantor can fund a trust during their lifetime (called an "inter vivos" trust) or someone can fund it after the grantor's death through their will (a testamentary trust). Many people choose to fund their trust gradually over time, transferring assets as circumstances allow. Others create a "pour-over will," which is a will that directs any assets not yet transferred into the trust to be placed there after death.

The cost of creating a trust varies depending on complexity and location, but typically ranges from a few hundred to several thousand dollars when working with an attorney. Some online services offer template trust documents at lower costs, though these may not account for state-specific rules or individual circumstances.

Takeaway: Creating a trust involves drafting a legal document with an attorney, signing it (and possibly notarizing it), and then transferring assets into the trust's name through a process called "funding."

The Trustee's Role and Responsibilities

The trustee is the person or institution responsible for managing a trust fund. This role comes with serious legal responsibilities, and understanding what a trustee does helps explain why choosing the right trustee is so important.

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A trustee's primary duty is called a "fiduciary duty," which means the trustee must act in the best interest of the beneficiaries, not in their own interest. This is a legal obligation. Trustees must manage trust assets carefully, keep good records, and follow the instructions written in the trust document. If a trustee violates these duties—for example, by making risky investments, stealing from the trust, or failing to distribute money when required—beneficiaries can sue the trustee and recover damages.

Trustees have several specific duties. They must invest and reinvest trust assets appropriately. For example, if the trust holds stocks, the trustee should monitor those investments and decide whether to keep them or sell them. Trustees must collect income from trust assets (such as rental income from property or interest from bank accounts) and deposit it