How a Trust Works
A trust is a legal arrangement by which a grantor establishes a fund, into which she puts money or other assets that a trustee will manage for a beneficiary. In the trust instrument -- the document creating the trust -- the grantor can give the trustee explicit instructions on how to invest or manage the trust, as well as detailed directions as to how, when and why the trust funds are to be paid out or expended for the beneficiary. For example, a parent as grantor may establish a trust with her children as beneficiaries and can appoint a friend, relative or her bank's trust department as the trustee.
Types of Trusts
Testamentary trusts -- or trusts established in a will to leave an inheritance to a minor child -- have distinct advantages over leaving the money outright to the child. In most cases, if a minor child inherits assets outright, he must have a financial guardian to handle his finances until he reaches 18 years old. At 18, the money or other assets becomes his to manage -- as he wishes. Including a testamentary trust in a will requires that the will go through probate, which may entail probate expenses and may cause a delay. Other types of trusts, including an irrevocable children's trust, are created and funded during the parent's lifetime and may help avoid probate costs and delays.
Placing money in a savings account or in a Uniform Gifts to Minors Act account for your children means that by law, the funds become property of the minor, with no restriction, when the child reaches 18 years old, or 21 in some states. Once the money passes to the child -- whether the money is physically given to the child at any age or when the child reaches the age of majority and receives the money from a minor's savings account -- the parent has no further control over how that money is spent. If the child would rather buy a sports car or concert tickets with the money than pay for college education or rent, he's free to do so. Either parent who places more than the annual exclusion amount in any one year into a minor's savings account or who hands it directly to the child will need to pay a federal gift tax.
Trust Terms and Benefits
Establishing a trust fund to pass assets from parent to child enables the parent to choose the trustee and to control the terms of disbursing the trust, even after her death. For example, a testamentary trust might limit trust disbursements to living and college expenses until the child graduates college (or turns 25, or even older), at which point the child can receive all the assets of the trust. This can help prevent the child from squandering the trust assets on inappropriate expenditures. Trust fund terms can provide the child with financial and parental guidance well into adulthood. Parental guidance can include requirements for drug or alcohol testing, for example, or the disbursement could be tied to positive behavior, such as graduating from college, starting a business or engaging in support activities for charities.