How Does a Trust Fund Work

What is a Trust Fund?

A trust is a legal arrangement whereby the owner of the assets entrusts the responsibility of holding and managing the assets to a person, a corporation or an association with the intention of providing for the beneficiaries. The individual who sets up the trust is known as the grantor, the donor or the settlor while the entity, entrusted with the task of overseeing the management of the trust, is known as the trustee. The beneficiary can be an individual, a group of people or an organization. Trust fund is the term used to refer to the assets held in a trust.

How to Set Up a Trust Fund?

In order to set up a trust, a document, specifying the beneficiaries, the trustees and the rights and obligations of the latter, needs to be prepared in accordance with the wishes of the grantor. The assets are then transferred to the fund. Transfer fees and taxes may be levied on the assets that are transferred to the trust. In the US, trusts can be set up in one of the following ways:

After-Death Trust: After-death trust, as the name suggests, comes into existence after the demise of the grantor who leaves a will to this effect. The purpose of this trust is to ensure that the beneficiary is well provided for in the absence of the grantor.

Living Trust: A living trust is intended to provide for the beneficiaries while the grantor is still alive. Living trusts can be revocable or irrevocable. In case of revocable trusts, the grantor and the trustee may be one and the same. Hence, it's advisable to nominate a successor who would be in charge of the trust if the grantor, who has the right to modify the terms of the trust, expires. In case of an irrevocable trust, the grantor hands over the control of the assets to the trustee(s).

How Does a Trust Fund Work?

How does a trust fund work, this question can be best answered by examining the workings of the following trust funds. Social Security Trust Fund in the US and Child Trust Fund (CTF) in the UK can help illustrate the modus operandi of trust funds.

Social Security Trust Fund: In the article titled "How is Social Security Funded", the funding of the social security system, using payroll taxes, was discussed in detail. The money from the levied taxes is credited to the Old Age and Survivors Insurance (OASI) trust fund and the Disability Insurance (DI) trust fund and is invested in Treasuries or Government bonds. For every dollar paid in taxes, 70 cents goes to a trust fund that was established to meet the financial needs of retirees aged 62 and over, their families and the dependents outliving the retirees; 19 cents is diverted to a trust fund that caters to the needs of Medicare beneficiaries while the remaining 11 cents, that is meant for the disabled and their dependents, goes into a separate trust fund.

Child Trust Fund (CTF): This trust fund is a savings and investment account which is meant to help children embark on their journey as adults. Once a child attains the age of 18, the child has the right to access the money in the account. All children born after 1st September, 2002, are entitled to receive a voucher of £250 in order to establish their trust fund account.

Trust funds for children are of the following types: child trust fund savings account, accounts that invest in shares and stakeholder accounts. A child trust fund savings account is meant for risk averse donors since the money grows on account of the interest earned. Stakeholder accounts are well diversified accounts that invest in the shares of a number of companies in accordance with the government regulations. Accounts that invest in stocks are meant for parents who are willing to assume above average risk in order to earn additional returns on their investment.

It's evident that trust funds help the donors provide for the beneficiaries. Beneficiaries can be children who are unable to support themselves financially or they may be retirees who have worked and contributed to a system that pledges to provide for them in recognition of their contribution.