Understanding Family Trusts and Trust Funds

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Misconceptions about family trusts are often propagated by certain films that play on cable television networks such as A&E, Lifetime Movies and the Hallmark Channel. In many films centered on the scandals of wealthy families, “trust fund babies” and “impenetrable dynasty trusts” will often be mentioned, but the reality of family trusts is that they are useful legal instruments that can be used across all income levels for estate and financial planning purposes.

A family trust is a legal instrument that allows the transfer of assets into an entity managed by a trusted party for the benefit of others. The individual who sets up the trust is known as the grantor while the manager is the trustee, who can be a relative, a family confidant, a law firm, or a finance professional.

Although family trusts can be set up in various structures, the most commonly followed is the revocable living trust, which can be dissolved at any time by the individual who formed the trust, the grantor, with proper instructions issued to the trustee. The trust construction must follow statutory provisions; for example, an irrevocable trust can be formed in Nevada for the purpose of establishing a “bullet proof” entity that is shielded from public scrutiny and that will resist legal challenges from creditors, heirs or third parties who may enter claims against family members.

Establishing a family trust is not something that should be done on a do-it-yourself basis. Prospective grantors, typically the head of household or primary breadwinner in the family, should consult a law firm, CPA practice or a seasoned trust company for this purpose. The process starts with a discussion about financial goals; the next step is to take account of the assets that will be transferred into the trust, followed by appointment of the trustee, acknowledgment of administration fees, and designation of beneficiaries.

The terms family trust and trust fund are interchangeable. As long as assets are present in a trust, this entity effectively functions as a fund, which is legally known as the corpus. The assets in the corpus can be managed, invested and distributed by the trustee, who can only follow instructions issued by the grantor.

Family trusts are often established to avoid probate, the court process of executing a will and administering the estate left by someone upon passing away. Trusts are inherently private; depending on their construction, they can reduce tax liability while they keep assets in the family and away from creditors. Bickering among family members who may feel disinherited is effectively quashed by trusts.

Since trust funds are legal and financial entities, they can be registered with the Internal Revenue Service to receive a Taxpayer Identification Number; this will allow the trust to conduct business with a certain level of revenue compliance.

The construction of a family trust fund can take on various dimensions; for example, the trustee can be instructed to distribute a lump sum payment to the daughter of the grantor when she graduates from college, such a move will give a financial incentive to the beneficiary to complete her education.