What Is a Trust Fund?

Image source: Getty Images.

A trust fund is set up by a person known as a grantor, for the benefit of another person, known as a beneficiary. A trust fund can contain cash, investments, real estate, and other assets, and can be a valuable tool in estate planning, and to ensure the financial security of a child or grandchild.

What is a trust fund?

Basically, a trust fund is a special type of legal arrangement set up by one person for the benefit of another person. In order to understand what a trust fund is (and so we can stop using the word "person" so much), you need to know the three types of people involved:

Grantor: The person who establishes a trust fund and contributes property to it.
Beneficiary: The person or people who will eventually benefit from the assets in the trust fund.
Trustee: The person or organization responsible for administering the trust as it was intended.

As an example, if you want to leave a large sum of money to your child, but are concerned about he or she using your money irresponsibly, you might set up a trust fund that only disburses your money when certain things happen (such as turning a certain age), or through a series of monthly or annual payments.

Different types of trust funds

There are many different types of trust funds, and here are some of the most common:

Revocable trust: Often referred to as a living trust, this type of account can be changed or modified during the grantor's lifetime.
Irrevocable trust: Cannot be changed or altered once it's created. Once property is transferred in, it cannot be taken out by anyone, even the grantor. This type of trust can be extremely useful in estate planning, as the assets held by an irrevocable trust are no longer considered to belong to the grantor for estate tax purposes.
Qualified personal residence trust: A specific type of irrevocable trust that can remove the value of a primary or vacation home from your estate. This can be especially useful for transferring a house to your children.
Irrevocable life insurance trusts: Used to remove a life insurance policy from your estate. By doing so, you surrender ownership rights in exchange for providing your beneficiaries with tax-free income.
Generation-skipping trusts: Allow you to transfer money to grandchildren or other beneficiaries at least two generations younger than you.
Charitable trust: Benefit a particular charity or are used for general charitable purposes.
Spendthrift trust: A trust that does now allow the beneficiary to sell or pledge the trust's assets.

Reasons to use a trust fund

There are too many possible reasons for using a trust fund to mention here, but here are some of the most common:

Making sure certain assets go to specific people after you're gone.
Providing money for education, or for a certain time in a loved one's life.
Minimizing estate taxes -- for example, by putting your home into a Qualified Personal Residence Trust (QPRT), it removes the home's value from the estate. The estate tax applies to money and property you leave to heirs, in excess of a certain lifetime exemption amount (currently $5.45 million). So, by using irrevocable trusts, it can take some of your assets out of the equation.
Donating to charity (through a charitable trust).

In a nutshell, a trust fund can help you with estate planning or making sure your money and possessions go where you want them to, either while you're still alive or after you die. Despite the common perception, trust funds aren't just for the rich; there are plenty of good reasons for middle-class Americans to take advantage of the benefits of trust funds. For example, if you want to make sure certain assets go to your grandchildren after you die, setting up a trust can help ensure that it will happen. And, trusts can help you pass along your money and properly more efficiently to your heirs than simply leaving a will and letting your estate settle through probate-- after all, the average noncontested probate period can take over a year, depending on what state you live in.

Of course, these are just some of the examples of when you might want to use a trust. There are literally thousands of situations where a trust could make sense, and not just for the rich.

The $15,834 Social Security bonus most retirees completely overlook If you're like most Americans, you're a few years (or more) behind on your retirement savings. But a handful of little-known "Social Security secrets" could help ensure a boost in your retirement income. For example: one easy trick could pay you as much as $15,834 more... each year! Once you learn how to maximize your Social Security benefits, we think you could retire confidently with the peace of mind we're all after.Simply click here to discover how to learn more about these strategies.

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.