Trust funds have provided the basis for countless movies and books over the years, but in reality, they're just living trusts – they don't necessarily guarantee a privileged beneficiary a lifelong source of easy cash. A trust fund is established when a grantor – the individual creating it – transfers ownership of his assets to a separate legal entity, the trust itself. When he dies, ownership of the assets transfers to his named beneficiaries. There are two basic forms of living trusts: revocable and irrevocable. Revocable trusts are more common.
One feature that separates a revocable trust from an irrevocable trust is that the grantor typically acts as the trustee. Until the time he dies or becomes incapacitated, he can manage his own trust assets. Revocable trusts also name someone to step in when the grantor can no longer do so – a successor trustee. The successor trustee might be a friend, a family member or even a professional, such as an attorney or a banking institution.
Because the grantor typically acts as trustee of his own revocable trust fund, he maintains control over the assets placed within the trust during his lifetime. He can sell them, change their named beneficiaries, or even liquidate and revoke the entire trust if he wants to. Assuming he doesn't revoke the trust, it holds ownership of and title to his property, including bank and investment accounts. Because he no longer owns these assets, they don't have to pass through the probate process when he dies. The successor trustee can step into the grantor's shoes and take control of the trust, distributing bequests according to the terms of the trust documents. The court doesn't have to get involved.
Revocable trust funds aren't perfect and there are several things they can't do. Because the grantor maintains control of his assets, any income generated by them is still reportable on his own tax return. If the income creates a tax liability, the grantor is responsible for paying it. Likewise, revocable trusts don't avoid estate taxation, and they can't shield assets from a grantor's creditors or from claims arising from liability lawsuits. Only irrevocable living trusts can accomplish these things because they involve the grantor turning control of his assets over to the trust forever, even before his death.
Closing the Trust
When the grantor dies and his successor trustee takes over, one of two things can occur. The successor trustee can distribute the trust's assets, transferring them to the grantor's named beneficiaries. When this is accomplished, the successor trustee closes the trust and it ceases to exist – it's not holding any property for the benefit of others any longer. Trusts can also remain open, however, and this is where the word "fund" comes into play in everyday language.
Maintaining the Trust
A grantor can direct that his trust remain open after his death instead. If the grantor left a large cash asset, his trust can retain possession of the account and the successor trustee can mete it out to beneficiaries in installments if this is what the grantor directed. Rather than receiving a large lump sum at the death of the grantor, beneficiaries receive periodic payments so the entire balance of the inheritance can't be dissipated through mismanagement, creditor claims, or even spouses in the event of divorce. The beneficiary doesn't actually own the account, but only the individual payments as they're made to him.
Beverly Bird has been writing professionally for over 30 years. She specializes in personal finance and w, bankruptcy, and she writes as the tax expert for The Balance.