What Is a Trust Fund? How Trusts Work and Who Uses Them

What Is a Trust Fund?

A trust fund — often simply called a trust — is a legal arrangement in which one party (the grantor or settlor) transfers assets to another party (the trustee) to hold and manage for the benefit of a third party (the beneficiary). Despite being associated with the ultra-wealthy in popular culture, trusts are widely used tools for ordinary estate planning, asset protection, and financial management.

Trusts can hold virtually any type of asset: cash, real estate, stocks, bonds, life insurance policies, or even a business interest.

The Three Parties in a Trust

• Grantor (Settlor): The person who creates the trust and transfers assets into it.
• Trustee: The person or institution that manages the trust assets according to the trust document. The grantor often serves as their own trustee in a living trust.
• Beneficiary: The person(s) who benefit from the trust — receiving income, principal distributions, or both.

Revocable vs. Irrevocable Trusts

Revocable Living Trust

A revocable trust can be changed, amended, or cancelled by the grantor at any time during their lifetime. It becomes irrevocable upon death. The main advantages are:

• Avoids probate, allowing assets to transfer quickly and privately after death.
• Continues to function if the grantor becomes incapacitated.
• Can be updated as circumstances change.

However, because the grantor retains control, assets in a revocable trust are still considered part of the taxable estate and are not protected from creditors.

Irrevocable Trust

An irrevocable trust generally cannot be changed once established. The grantor gives up control of the assets transferred into it, but gains significant benefits:

• Estate tax reduction: Assets removed from your estate may reduce estate tax liability.
• Asset protection: Assets in an irrevocable trust may be shielded from creditors and lawsuits.
• Medicaid planning: Transferring assets into an irrevocable trust (with appropriate timing) can help qualify for Medicaid while preserving wealth.

Common Types of Trusts

Testamentary Trust

Created through a will and takes effect only after the grantor's death. Often used to manage assets for minor children until they reach a specified age.

Special Needs Trust

Holds assets for a beneficiary with a disability without disqualifying them from government benefits like Medicaid or Supplemental Security Income (SSI).

Charitable Trust

Transfers assets to a charity while potentially providing income to the grantor or other beneficiaries. Includes Charitable Remainder Trusts (CRT) and Charitable Lead Trusts (CLT).

Spendthrift Trust

Restricts a beneficiary's ability to transfer their interest in the trust to others, protecting the assets from the beneficiary's creditors or poor financial decisions.

Generation-Skipping Trust

Passes assets directly to grandchildren or later generations, bypassing the intermediate generation to minimize estate taxes across multiple transfers.

How Assets Are Distributed

The trust document specifies the rules for distributions. A trust can provide:

• Income distributions: Regular payments from investment income (interest, dividends, rent).
• Principal distributions: Access to the underlying assets under specific conditions.
• Discretionary distributions: Distributions made at the trustee's judgment, based on the beneficiary's needs.

Trustees have a legal fiduciary duty to act in the best interest of the beneficiaries and follow the trust document precisely.

Tax Considerations

Trusts have their own tax identification numbers and file their own tax returns. Income earned in a revocable trust is taxed to the grantor. Income in an irrevocable trust is taxed to the trust at compressed tax rates (trusts reach the highest tax bracket quickly), or to beneficiaries if income is distributed to them.

When Is a Trust the Right Choice?

A trust may be worth considering if you want to avoid probate, have a blended family or complicated family situation, want to provide for a minor child or disabled family member, own real estate in multiple states, have a taxable estate, or want to control how and when beneficiaries receive money.

Setting up a trust requires working with an estate planning attorney and is generally more expensive upfront than a simple will — but it can save significantly in legal costs, taxes, and administrative burden for your heirs.