This post was originally published on our blog at Beyond Your Hammock
For most people, the phrase “trust fund baby” does not come with positive associations.
It’s a description that conjures images of spoiled children that may grow up to be dilettantes as adults; of people that seem divorced from the reality of working for a living or being financially responsible for their own futures.
But setting up a trust fund for kids can actually be a useful — even essential — financial planning tool for more families than our preconceived notions about trusts might lead us to believe.
Setting up a family trust is a common part of estate planning for many of our clients — and most of our clients are self-made individuals who worked hard to grow their assets independently. They didn’t inherit family money, and didn’t necessarily grow up with trusts of their own.
But setting up a trust fund for kids is an important step in their own protection planning process, precisely because they’ve built up wealth outside of retirement accounts with clear beneficiaries.
Here’s what you should keep in mind about trusts, and what to consider to help you decide if setting up a family trust should be on your own planning to-do list.
The Purpose of a Trust for Kids and Your Family
A trust is a legal entity that takes ownership over the assets placed within it. These can range from financial accounts to physical property to homes and other real estate.
You can accomplish various planning goals with the use of a trust — but if you’re specifically wondering if a trust fund for kids makes sense for your family, the most important thing to know may be that a trust lets you name your children as beneficiaries of what you have… without necessarily giving them (or their guardians) full control over that wealth.
A trust can also help your family avoid the probate court process while keeping things private; all probate proceedings are public record. It streamlines the distribution of your assets (especially at an emotional time).
But a will can perform similar functions. So is there a meaningful difference?
A will simply bequeaths wealth to your children, and it can be challenged by third parties. It does not stipulate rules or limitations over how they use whatever assets you leave for them once they take ownership, and is still subject to the probate court process.
A trust, on the other hand, does allow you to enforce specific guidelines, requirements, or limitations on what you leave for your kids. It’s also harder to challenge the stipulations of a trust.
Far from creating the spoiled “trust fund baby” you might fear, a trust fund for kids can actually help them responsibly manage an inheritance you leave for them. A trust can distribute money to heirs over time (rather than all at once), provide funds only if certain criteria are met, or withhold money if a particular requirement isn’t met.
This becomes even more important for minor children who may be left in the care of a guardian should something happen to you, as a trust also stipulates how a caretaker of a child under 18 may use the funds left to that child. The guardian must follow the rules of the trust, which is managed by a separate trustee (but more on that in a moment).
When You Do (and Don’t) Need to Establish a Trust
A trust might be essential for your family — or, it may be something that you don’t necessarily need. How can you tell which camp you’re in?
Here are some general guidelines that can indicate whether you’re just fine without this extra piece of estate planning, and when it’s time to consider it. At the end of the day, however, it’s best to talk through your specific situation with an estate planning attorney in your state to determine the best course of action for your family.
When You May Not Need a Trust:
- You don’t have minor children. If you don’t have dependents (or none of your heirs are under the age of 18), a will may be sufficient. When minor children are in the picture, however, a trust can provide more protection for them.
- You don’t need to stipulate exactly how your assets are distributed or used. A will might be sufficient if you do not have specific wishes for how any beneficiaries use their inherited assets. For example, a married couple with no children may simply leave their assets to adult family members (like their siblings), knowing those heirs would have full control over how the money is used. If you prefer to stipulate precisely how and when the inheritance you leave is used, a trust might be a better way to go.
- You don’t have financial assets outside of retirement accounts. If your current investments consist of money in a 401(k) or similar plan, like a 403(b), and/or IRAs (including traditional, Roth, SEP, and SIMPLE accounts), you may not need to set up a trust in order to ensure those funds get to your children or other heirs. You can set up beneficiaries on these accounts; if something happens to you, the assets automatically pass to those beneficiaries. You can set up primary and contingent beneficiaries, and stipulate what percentage of assets go to each person you name. Keep in mind that if your children are minors, then their guardian will have full access to their inherited assets unless you have a trust.
- Your bank accounts are payable or transferable at death. Having this designation on bank accounts means the money could go straight to a person you name as the beneficiary, without going through probate. (You might see this abbreviated as “POD” or “TOD.”)
- You’re still building up your assets and need to focus your available cash on contributing to savings and investments. Trusts aren’t free to set up; depending on your situation and your state, it could cost several thousand dollars to establish a trust. If all other signs point to “you need a trust,” don’t let the cost dissuade you from putting an essential piece of your estate plan in place. But, if you discuss with a financial planner and/or estate planning attorney and you don’t feel it’s critical right now, you might want to wait. You can always revisit this as your life changes and evolves in the future.
This doesn’t mean if you check any or all of the boxes above, you should actively avoid a trust. Many people still choose to place assets (even those with already-named beneficiaries) within a trust for their family because they don’t want to simply pass on a lump sum to their children with no strings attached.
When It Might Make Sense to Establish a Trust Fund
It might make sense to consider a family trust if:
- You have assets beyond money you’ve saved into retirement accounts (like taxable brokerages, for example)
- You have minor children
- You have adult children but do not necessarily want to leave their inheritance to them on a “no-strings-attached” basis
- You want to stipulate precisely how inherited funds may be used or accessed by your heirs
- You have, for whatever reason, a more complex financial or family situation (for example, if you’ve been married more than once and/or have children from multiple marriages, if you want to leave money to individuals outside of your immediate family, if your assets go beyond qualified retirement accounts, and so on)
- You have tangible assets, like jewelry or art
- You own your own business, which may factor into your estate planning
- You own property in multiple states
These are just a few of the common reasons we see clients set up a trust. This is by no means an exhaustive list, but should give you an idea of when it makes sense to start looking seriously at this as a step in your overall financial planning.
The Various Roles You Need to Fill If Establishing a Trust
Other considerations to bear in mind when setting up a trust fund for kids or for your family include who you will name to various legal roles associated with that trust.
The three main roles involved in a trust are a grantor, a beneficiary (or beneficiaries), and a trustee.
If you establish the trust, you’re the grantor. The beneficiaries are those you name to receive the assets or property that you place into the trust. The trustee is a third party that you need to name as the individual responsible for operating or managing the trust; this role comes with a serious fiduciary duty and commitment.
A trustee is expected to maintain their role until the assets of the trust are completely distributed — which could take years or, if you’re setting up a trust as a young and healthy individual, hopefully decades. Given this, you need to choose your trustee with care and ensure that you communicate with them about this role before legally naming them to this position.
Some people may not feel comfortable or prepared to take on this responsibility, and it’s better to know that upfront rather than down the road.
Should Your Trust Be Revocable or Irrevocable?
If you do decide to explore setting up a family trust, you’ll have to decide on the type: revocable or irrevocable.
Revocable trusts are just that: revocable, meaning you can change things. You can add and remove assets and beneficiaries from the trust, making them more flexible than irrevocable trusts.
Irrevocable trusts are, again, as the name suggests, irrevocable. Once you set it up, the assets in the trust are completely outside your control. The benefit of this is that the assets in the trust are removed from your estate, which is helpful for tax planning purposes on high-value estates.
For most folks, a revocable trust provides a good way to go because you can make changes to it as your life continues to unfold and evolve. That includes amending the revocable trust into an irrevocable trust, if one day that makes more sense for your situation.
Yes, You Need to Work with the Pros for This
Bear in mind that nothing here should be taken as specific legal or financial advice for what you should do. Everyone’s situation is different, from your overall goals to specific considerations that may require you take a different path than suggested by rules of thumb or general guidelines.
A good first step would be to develop an overarching financial plan with a financial planner. That should cover topics including:
- Goal-setting, and identifying your top priorities and values
- Scenario planning, so you understand what you’re currently tracking to achieve and how that stacks up with what you want to achieve (and to help you evaluate the pros, cons, and tradeoffs of various decisions)
- Specific advice for adjustments, changes, or actions to take to ensure what you do today is helping you make progress toward what you want tomorrow
- Suggestions for optimizing your financial plan
- Investment strategy and portfolio management
- Protection planning
Hitting on these big-picture topics can help you develop the context you need for making a number of important financial and life decisions… including on whether you need a trust fund for kids or for your family as a whole.
Estate planning falls under that broader “protection planning” category (which also includes topics like insurance). Within estate planning, there are a lot of considerations you might want to touch on with your financial planner:
- Understanding wills, and what yours might need to include
- Identifying individuals you’d want to grant power of attorney to, or name as guardians of minor children
- Establishing healthcare proxies
…and, of course, setting up a trust is on this list, too.
A financial planner is helpful in this conversation because they can help keep the big picture in mind, and explain how estate planning specifically fits in. But when it comes to actually executing an estate plan, you should consult with an estate planning attorney familiar with the laws of your state.
For something as important as establishing these documents and legal entities (like a a trust), you don’t want to work through a DIY website. Go to a reputable, experienced, knowledgeable estate planning attorney who frequently works with clients like you.
Need help uncovering more strategies to use to grow your wealth and set your family up for success? A financial planner could help. Learn more about our process and what we do for our clients here.