Setting Up a Trust
Have you ever heard of that term “trust fund baby”, where an ultra wealthy parent puts money aside for their child when they grow up. Despite what we may think of trust funds, they’re not exclusively for the ultra wealthy - middle class people set them up as well.
How Trust Funds Work
Imagine you've worked hard your whole life and have built up a sizeable savings account. The reality is that someday, you will pass away - so what happens to that money? Typically you would want your hard-earned savings to go to the people you love, or the charities or causes that you believe in.
We’ve seen time and time again throughout history that giving a huge lump sum of money to someone who may not be as financially savvy as you, can lead to more harm than good. You want to help them by giving them your money, but giving too much all at once can actually be quite detrimental.
What about loved ones who are not as financially savvy as you?
You could be concerned about leaving them a large monetary gift because they might spend it irresponsibly, blow the money, or not know what to do with it due to lack of experience. Furthermore, what if you want your hard earned generational wealth to last…. well generations.
You could set up a trust fund.
Irrevocable Trust Fund
One option is that you should set up a living irrevocable trust fund. This type of trust can be setup to pay out funds when certain conditions are met (you can still be alive for this to happen).
Through this option, your assets could be in cash, stocks, real estate or other valuable investments.
How do you set this up?
You need a lawyer. You meet with an attorney and decide on the beneficiaries, rules and stipulations of the trust. For example, beneficiaries receive a monthly payment or can only use the funds for education expenses or for medical reasons or the purchase of a home. The nice part is that it’s your money, and so you get to decide the rules. This prevents the beneficiary from being irresponsible with how the money is spent.
Who owns the money?
The money is not the property of the person receiving it. Because of this, a child applying for financial aid would not have to claim these trust funds as assets. As a result, there will be no impact on eligibility for needs-based financial aid (that’s a bonus). However, the money isn’t exactly in your control from the sense that you cannot withdraw and spend it as you see fit anymore. The money now sit’s the hands of a trustee - also known as a bank, attorney, or other entity set up for this purpose.
What are the limitations?
The trust can be setup for future generations of children as well, making the trust your lasting legacy for an indefinite number of generations. This ensures your generation wealth truly lasts… generations.
Note - because it's irrevocable, you don't have the option to dissolve the trust fund. Once you place assets in the trust, they are no longer yours, remember they are in the care of a trustee to be given to the beneficiary according to the stipulations you created.
If you recall, since the assets are no longer yours, you don't have to pay income tax on any money made from the assets. With proper planning, the assets can be exempt from estate and gift taxes too! These tax exemptions are a primary reason that some people set up an irrevocable trust. If you are in a higher income tax bracket, setting up the irrevocable trust allows you to remove these assets from your net worth and move into a lower tax bracket.
There are some downsides to setting up a trust. The biggest downside is attorney fees. Think of a trust as a new person. This new person has to pay taxes and the so to orchestrate all this with minimal headache, the trust has to be written in a very particular way in order to make it as tax-efficient as possible. Trust attorneys are kind of expensive. A traditional irrevocable trust will likely cost a minimum of a few thousand dollars (or more).
Revocable Trust: Like the name suggests, this is similar to the above example, except that it’s revocable. If you (having set up the trust) experiences health concerns, a revocable trust allows the your chosen trust manager to take control of the principal for you.
Revocable trusts let the living grantor (you) change instructions, remove assets or terminate the trust. Irrevocable trusts cannot be changed; assets placed inside them cannot be removed by anyone for any reason.
If you don't want to set up a trust fund, there are other options, however, none of these give you as much control over your assets as a trust.
Last Will and Testament: Writing a will costs much less money, but your property is subject to more taxes. The terms of the will (if left to multiple beneficiaries) can also be contested through probate (and attorney fees can’t add up!). Additionally, there is less reassurance as to how your assets are used.
Living Will: A living will gives health care/mental power of attorney to a person of your choice. It gives this person the power to implement the medical treatment you wish, tells doctors, family members, and the courts your wishes for life-support and other medical procedures if you were to become brain dead, unconscious, terminally ill, or otherwise unable to communicate.
Power of Attorny: Power of attorney gives the person of your choice the power to manage your financial affairs if you become incapable of managing them yourself. It gives this person the power to handle such day-to-day tasks as: paying bills, doing tax returns, opening your mail, banking, taking care of pets, voting etc…
Without a power of attorney, a spouse has no legal authority to do any of these tasks on your behalf if you become disabled.
A trust fund might be right for you, should you wish to leave money to children or grandchildren but still control how that money is used. Despite what people think, it's not just available to high-net-worth individuals, it’s an option for everyone.