Establishing a Trust Fund

Who Needs Trust Funds?

If you’ve heard of trust funds but don’t know what they are or how they work, you’re not alone. 

Many people know just one key fact about trust funds: they’re set up by the wealthy as a way to protect passing on significant sums of money to family, friends, or entities (charities, for example) after they pass away.

However, only part of the conventional wisdom is a true look at this website to find out more.

Trust funds are designed to allow a person’s money to continue to be used in specific ways after they pass away, and to avoid their estate going through probate court (a time-consuming and expensive legal process). 

But trusts aren’t only useful for ultra-high-net-worth individuals, the middle-class can use trust funds as well, where setting one up isn’t out of financial reach.

The Mechanics of Trust Funds

To understand how a trust fund operates, let’s look at an example. You’ve worked hard all of your life and have built up a comfortable savings cushion. You know that sometime in the future you’re going to pass away, and you want your hard-earned savings to go to the people you love or the charities or causes that you believe in.

Now, what about loved ones who are not as financially savvy as you? You could be concerned about leaving them a lump-sum gift because they might use it irresponsibly.

Furthermore, you may even like to see your money carry over for generations to come. If this is how you feel, then you should set up a living irrevocable trust fund. This type of trust can be set up to begin dispersing funds when certain conditions are met. There is no stipulation that you cannot be alive when that happens.

You can place cash, stock, real estate, or other valuable assets in your trust. You meet with an attorney and decide on the beneficiaries and set stipulations.

Maybe you say that the beneficiaries receive a monthly payment, can only use the funds for education expenses, expenses due to an injury or disability, or the purchase of a home. It’s your money, so you get to decide.

Eligibility For Need-Based Financial Aid

Although the trust is irrevocable, the money is not the property of the person receiving it.1 Because of this, a child applying for financial aid would not have to claim these funds as assets. 

As a result, there will be no impact on eligibility for need-based financial aid. The trustor can also establish trusts for future generations of children, making the trust a lasting legacy for an indefinite number of generations.

Because it’s irrevocable, you don’t have the option of later dissolving the trust fund. Once you place assets in the trust, they are no longer yours. They are under the care of a trustee. A trustee is a bank, attorney, or other entity set up for this purpose.

Since the assets are no longer yours, you don’t have to pay income tax on any money made from the assets. Also, with proper planning, the assets can be exempt from estate and gift taxes.

These tax exemptions are a primary reason that some people set up an irrevocable trust. If you, the trustor (the person establishing the trust) is 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.

Why Set Up a Family Trust?

There is a range of positives when it comes to setting up a family trust, but there are some negatives too (just like anything).

Advantages

Tax Minimisation: Distributions by a trust result in lower incomes for tax purposes.

Property Investment Flexibility: Trusts have much looser rules than super when it comes to holding assets e.g. property.

Retirement Planning: As family trusts are quite flexible, this offers the potential for wealth to be accumulated and then used in conjunction with superannuation amounts the following retirement.

Capital Gains Tax: Family trusts have CGT benefits that companies do not have, as there is a 50% discount on capital gains for assets held over 1 year (this does not apply to companies).

Asset Protection: An example of this is purchasing a home for a child to reside in but not needing to forfeit ownership, as the ownership remains with the family trust.

Disadvantages

Distribution of losses: Capital or revenue losses can not be distributed to the beneficiaries of a family trust. This, therefore, means that if the trust suffers a net loss, none of the beneficiaries can offset that loss against any other assessable income that they may have.

Tax risks: Never complete any sort of ‘tax avoidance’ behaviour – speak to your tax accountant and they can act accordingly.

Ownership name of assets: If a trust owns the property, the trustee’s name is on the relevant paperwork and they are the legal owner.

Loss of ownership of assets: If the property is managed through a family trust, you lose personal ownership.

Administration costs: All of the above cost money and time in the long term.

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