Trust Funds Explained

by Vanessa Cross
Legal counsel is often sought when establishing a trust.

Legal counsel is often sought when establishing a trust.

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Trusts are used in various ways for estate planning and business planning. They are often used to provide an income to others without their direct involvement in managing the assets in the trust. In estate planning, trusts are often established to avoid costly and contentious probate proceedings. For business planning, a trust may be used to pool investment assets for centralized management by a designated trustee.

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Creating a Trust

Aside from constructive trusts created by courts in equity, trusts are generally created by a written trust agreement and transfer of trust assets from the control of the donor to a trustee, which can be either a business entity or an individual. The trust as a device creates a separate "beneficial" and "legal" ownership interest in property being used for the trust. In the United States, individual state laws govern the creation and operation of a trust. Federal laws may apply, such as those under federal tax laws and other federal laws that impact trusts.

How Trusts Work

Here is a simple example of how a trust works. Grandmother Generous gives her daughter, Mrs. Trustworthy, 1000 shares of Best Quality Inc.'s stock. Under a trust agreement, Trustworthy agrees to hold and invest this property for the benefit of Grandmother's granddaughter Tayana, and for Tayana's children. The stock Grandmother gave to Trustworthy, the trustee, is called the trust fund, or principal, or corpus. The trust fund could be real estate, cash, insurance, a business or any other asset with ascertainable value that can be assigned or owned. Keep in mind that the trust corpus can change as new investments are made. For business planning, businesspersons with a high exposure to business litigation may benefit from asset-protection trusts to shield personal wealth before a claim arises, according to Texas attorney Duncan Osborne, reporting for Bloomberg News. These trusts may be funded by liquid assets, such as stocks and bonds. Distributions may be taken if needed, but trust assets are generally beyond the reach of future creditors.

Parties to the Trust

The donor to the trust is also called a trustor, settlor or grantor. For example, Mrs. Trustworthy, as a trustee, is the legal owner of the trust property. She is the personal representative of the trustor, authorized to carry out the trustor's objectives as expressed under the trust agreement. The beneficiary of the trust, Tayana, has a life estate in the trust, with a right to income during her life. Her children have a remainder interest in the trust, with a right to the income after the life estate ends. A trust can have more than one trustee and can designate a substitute trustee or successor trustee.

Types of Trusts

There are two types of trusts: the testamentary trust and personal trust. The testamentary trust is created under the grantor's will and takes effect after the grantor dies and a legal representative is appointed through probate court. The personal trust is also called a living trust or inter vivos trust because it begins operation while the grantor is alive. There are two types of personal trusts, 1) those where the grantor designates himself as the trustee, called Under Declaration of Trust (U/D/T), and 2) when the grantor and trustee are different persons, called Trust Under Agreement (U/A). While, a grantor can designate himself as trustee, this may be construed as retaining ownership interest in the trust assets and can have significant tax implications. An attorney should be consulted, especially if the goal is to remove trust assets out of your taxable estate and out of probate proceedings.

Trust Agreement

Except for the limitations of state law, a trust settlor can make her own rules about how the trust will operate. The trustor establishes the trust's purpose, duration, beneficiaries, distribution amounts and times, and can also create conditions for receiving trust fund income. Local counsel should be consulted concerning how local state law places limitations on the powers of the trustee or time limits on how long property may be held in trust.