Do Middle Class People Set Up Trust Funds?

Q. My mother is considering setting up trust funds for her grandchildren, hoping to give them a solid head start on adulthood when the time comes. She would like to provide them with guaranteed financial security later in life and help cover the costs of important life events, such as paying for college, a wedding, and a first home.

She hasn’t decided how she would want the trusts to work yet. She mentioned that she is considering setting them up to help pay for their college educations, with the stipulation that they can access another portion of the funds only after they graduate. She is also considering hinging the gifts on certain events, tagging some for college, some for a wedding, or a portion toward the purchase of a first home. Or, in another scenario, the grandchild will receive regular increments of money, but the trustee can distribute more for specially-tagged needs. One of the grandchildren has special needs, so she would need his trust fund to be specially tailored for his situation.

My mother is far from wealthy, and with six grandchildren, it won’t be a vast sum of money for each one. I thought only rich people set up trust funds. Do people in my mother’s situation use them for the purposes described? Thanks for your help!

A. When many of us think of trust funds for children, an image of wealthy, over-privileged teenagers driving fancy cars, attending expensive private schools, and spending summers traveling overseas come to mind. But these days, that’s a stereotype with little basis in fact. Trust funds can be powerful estate planning tools for families from all sorts of socioeconomic backgrounds.

“Trust funds aren’t just for the uber-wealthy anymore — more people than ever are faced with making crucial financial decisions for their heirs,” says Hillary Hoffower, Senior Reporter on millennial wealth for Business Insider. “Middle-class citizens can set up trust funds too.”

But, before you can decide if a trust fund is right for your children or grandchildren, it’s important to understand what a trust fund is, how it works, and the possible advantages and disadvantages that may arise for you and your heirs.

What Is a Trust Fund?

The definition of a trust fund, synonymous with a trust, is “a special type of legal entity that holds property for the benefit of another person, group, or organization.” Trust funds offer a number of important advantages for families looking to manage their assets wisely. Depending on the type of trust you establish, you can use it for a variety of purposes, such as:

  • Distributing assets to heirs while minimizing / eliminating the hassles and expenses of probate;
  • Providing charitable gifts;
  • Ensuring the financial well-being of family members with special needs;
  • Protecting assets from lawsuits and creditors;
  • Protecting assets from the catastrophic expenses of nursing home care;
  • Reducing / eliminating estate taxes.

Trust funds are also essential for families who want to ensure their children and grandchildren under the age of 18 will be beneficiaries of their estate, but also want to be able to set specific rules that control how and when the assets will be distributed and used.

A trust fund can be set up for minor children, to distribute assets to adult children over time – for instance, at ages 25, 35, and 45 – in order to give them more than one chance to not blow an inheritance. In some cases, trust funds can be used for children with special needs, so that they are not disqualified from government benefits such as Medicaid and supplemental security income (SSI). In short, setting up a special needs trust for a child with special needs can help provide them with financial security once you’re no longer around. Read more about special needs trusts here.

How Does a Trust Fund Work?

Trusts typically involve three parties or entities: the grantor, who sets up the fund; the beneficiary, who the fund is established for; and the trustee, who oversees the fund. Trusts can hold anything of value, including money, real estate, stocks — even art and antiques.

How a particular trust fund works depends on the type of trust that is established and the rules that the grantor creates. When setting up a trust, it is the grantor’s responsibility (with help from an experienced estate planning attorney and/or elder law attorney) to determine how the assets will be managed and what requirements must be met in order to trigger distributions to the beneficiaries. The grantor is also responsible for choosing a trustee to manage the fund.

Although there are many different types of trusts, the two main types are revocable trusts and irrevocable trusts. Read more about revocable and irrevocable trusts in my article, “What’s the Difference Between a Revocable and an Irrevocable Trust?”

What Are the Advantages of Setting Up a Trust for Your Child or Grandchild?

When it comes to setting aside assets for minors, trusts also have a major advantage that many other types of accounts do not: trust beneficiaries cannot access the funds until the age you choose, typically at least 25, which is when science tells us the brain is fully developed. Until that time, the assets are managed by a reliable trustee. These are some other advantages:

  • You can put conditions on how and when your assets are distributed. For example, you might stipulate that the money can only be spent on education. Or, you might impose rules on how old the beneficiary needs to be before she gains control over the money.
  • You can prevent your beneficiaries from spending all the money at once by instructing that a trust be paid out at intervals. As described previously, maybe they get one payment when they turn 25, then at 35, and again at 45.
  • You could insert a “spendthrift” clause. Many trusts include a spendthrift clause, where money is distributed to the beneficiary over time, under the supervision of an independent trustee. Under a spendthrift clause, the trustee is typically given broad discretionary powers to provide beneficiaries with funds to maintain their lifestyle, without allowing the beneficiary direct access to any of the money in the trust. With a spendthrift clause, you also stipulate that the assets in the trust can’t be sued to satisfy debts. For example, what if your adult child or grandchild spent a ton of money and got into massive debt? He or she couldn’t bankrupt himself or herself by sapping up all the trust fund money to pay it off.
  • You could skip a generation. You could specify that your money should jump a generation and go directly to your future grandchildren.
  • You can distribute assets to heirs efficiently without the cost, delay, court filings, and general nightmare of probate.

What Are the Disadvantages?

Lack of Court Oversight

One possible disadvantage of a living trust (one created while the grantor is living) involves lack of court oversight. Although a living trust  is usually set up in large part to shield assets from the nightmare of probate, some people actually like the idea of probate because of the court supervision. Sadly, some people do not have any family members or close friends or professional advisors who they feel they can trust with oversight of trust funds, and they therefore like the safety that comes from the required court supervision that is typically part of the probate process. Oversight can be built in to a living trust through the use of a trust protector, but the same people that may not have a trusted loved one to act as trustee may not have anyone they trust to serve as a trust protector.

Financial Aid

Another possible disadvantage has to do with financial aid for your child’s college education. If your child fills out the FAFSA (Free Application for Federal Student Aid), they’ll be required to report their trust fund, which can significantly reduce the amount of money they receive.

Trust Funds are Effective Planning Vehicles

With proper planning, careful analysis of your family’s unique needs, and the help of an estate planning professional, such as the attorneys at the Farr Law Firm, a trust could be the perfect way to ensure your offspring benefit from your hard-earned savings — without spending all that money at once.

If you’re a potential client who would like more information about trusts and/or trust funds, please call our office to make an appointment for a no-cost introductory consultation:

Fairfax Estate Planning Attorney: 703-691-1888
Fredericksburg Estate Planning Attorney: 540-479-1435
Rockville Estate Planning Attorney: 301-519-8041
DC Estate Planning Attorney: 202-587-2797

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About Evan H Farr, CELA, CAP

Evan H. Farr is a 4-time Best-Selling author in the field of Elder Law and Estate Planning. In addition to being one of approximately 500 Certified Elder Law Attorneys in the Country, Evan is one of approximately 100 members of the Council of Advanced Practitioners of the National Academy of Elder Law Attorneys and is a Charter Member of the Academy of Special Needs Planners.