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What is a trust fund and how does it work?

What is a trust fund and how does it work?
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You may think trust funds are only for the rich and famous. After all, Beyonce and Jay Z’s three children have a trust fund of $1 billion each. The likelihood is that none of us are even close to that level of wealth. But what you may be surprised to hear is that trust funds can be a pretty useful tool for estate planning. Let’s take a look at what a trust fund is and why you might want to use one.

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What is a trust fund?

A trust fund is an arrangement where the ownership of assets or money is transferred to a private fund. The arrangement is usually laid out in a legally binding document called a ‘trust deed’.

It is usually used for estate planning. It is basically a way for you to manage how your assets are spent by another party. So parents may well set up a trust fund for a child but specify that the money be used to buy a property.

A trust fund is there to limit how the money can be used. This could be that the money is not available until the beneficiary is of a certain age – Jay Z wouldn’t want Blue Ivy spending $1 billion on LOL dolls, for example.

How does it work?

There are three roles involved when it comes to how trust funds work:

  • Settlor: This is the person providing the assets. They get the say-so on who gets the money and how it will be used.
  • Trustee: It’s the trustee’s job to run the trust. They need to adhere to whatever is laid out in the trust deed.
  • Beneficiary: This is the person the trust was set up for. Typically beneficiaries are too young to manage the assets themselves, or they are not good at money management.

Once a trust is set up, the assets are no longer considered the possession of the settlors. Which means that they are safeguarded from creditors, lawsuits and family disagreements.

A trust fund is managed by a trustee until the time comes for the beneficiary to, well, benefit.

Why would you want one?

Unless you are a millionaire, you might be thinking that a trust fund is not for you. But the nature of it actually means there are some benefits to setting one up even for the average earner.

  • The most common reason to set up a trust fund is to control and protect family assets. So it’s back to that specifying how the money can be used. Think of it as making sure there is money for your child to buy themselves a house, not a one-way ticket to the full moon party in Thailand.
  • You may want to use a trust to minimise your exposure to inheritance tax. The value of the trust fund won’t be counted when your inheritance tax bill is worked out. That’s because the assets technically belong to the trust, not to you, the settlor.
  • Another reason for setting up a trust fund is if someone is too young to handle money. Where do you think the phrase ‘trust fund babies’ came from?

Just remember that tax treatments depend on the specific circumstances of the individual and may be subject to change in the future.

What are the pros and cons of a trust fund?

A trust fund is a popular way of structuring financial affairs. There are potential tax benefits to having one in place, and it could create a ‘safe haven’ for family finances.

It could also simply be a good financial tool in order to support someone who can’t manage their own money. Or if you are incapacitated in any way, it could be a way to make sure your own money is used to look after you.

The disadvantages are that once the money is placed in trust, it’s no longer under your control. So if you suddenly find yourself in financial difficulty, it is very difficult to get that money back from the trust.

A trust also costs money to set up. As it is a legally binding document and you will need a solicitor involved, you are probably looking at around £1,000 or more in set-up costs.

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