When you picture a child who has a trust fund, you probably envision someone who is wealthy, spoiled, and entitled. If that’s the image in your head, you may not have ever dreamed that you would set up a trust for your child. You might be surprised to learn that making your child the beneficiary of a trust is one of the best things you can do for them and their future.
Once upon a time, trusts were used primarily by the wealthy; that’s where the stereotype of the spoiled “trust fund baby” comes from. When you understand what a trust actually is, and what it can do for you and your family, you may conclude that it is time to set up a trust for your child’s benefit.
What is a Trust?
A trust is a legal relationship consisting of three parties: the grantor, who creates the trust and places assets or funds in it; the trustee, who controls and manages trust assets; and the beneficiary, who receives distributions from the trust.
The trust is established by a trust document, which specifies the terms of the trust. There are certain basic legal requirements for a trust, but within those requirements, a trust can be customized to honor the grantor’s intentions. For instance, the trust document specifies not only who the beneficiaries are, but the circumstances under which they will receive distributions from the trust. If you wished, you could create a trust that would make distributions to beneficiaries as they complete certain milestones, such as graduating college, getting married, or buying a house. Or you could direct that distributions be made at certain ages, or simply at the trustee’s discretion.
There are many different kinds of trusts. Depending on how they are set up, they may serve different purposes. Some trusts are established in such a way as to minimize tax burdens, or to protect beneficiaries from creditors. All trusts bypass probate, meaning that any funds in them do not need to go through a lengthy court administration process. This is one reason trusts have become increasingly popular estate planning tools in recent years.
One of the most common types of trust is the revocable living trust. As the name suggests, the trust can be revoked or amended by the grantor at any time. With a living trust, the grantor can also serve as the trustee and beneficiary of the trust during their lifetime; essentially they can use and enjoy trust assets just as they could if they owned them. When the grantor dies, a successor trustee named in the trust document immediately takes over management of the trust. They administer the trust for remaining beneficiaries as the trust instrument directs.
How a Trust Protects Your Child
Without a trust, if you die while your child is a minor, they could become entitled to receive their entire inheritance when they turn eighteen. Some eighteen-year-olds are more mature than others, but very few are equipped to responsibly handle receiving a significant amount of assets at once.
Any number of nightmare scenarios could ensue. Your child could spend the money irresponsibly, and then find themselves without a means of support. Your child could be taken advantage of by unscrupulous “friends.” If your child has or incurs debt, their creditors may be able to seize all or part of their inheritance to satisfy the debt.
All of those scenarios assume the assets last until your child turns eighteen. Before a minor child turns eighteen, their assets are controlled by a conservator, usually the person who is serving as their guardian. Let’s say you have named your brother as guardian. He is a loving uncle, a good cook, and coaches your child’s soccer team. But he also has a gambling problem. If he has access to your child’s assets, he could “borrow” from them repeatedly, intending to return the cash when he wins, until the funds are gone. Even in a less extreme situation, a person who makes a good guardian is not necessarily a wise money manager.
Setting up a trust for a child can protect their assets not only now, but in the future. For instance, if your child receives their inheritance outright, they might place those funds in a joint bank account with a future spouse. At that point the funds are considered “marital property.” If the couple divorces, your child’s ex-spouse could walk off with much of your child’s inheritance. By contrast, if you have created a trust, those funds can be kept separate and out of a spouse’s reach in divorce.