Few things strike more fear into a parent than the thought of a child fending for herself if the parent dies. While this may be the primary reason many parents begin to think about trust funds for their children, it's certainly not the only motivation. Whether you're looking for a tax-smart way to pass on an inheritance, caring for a special needs child or simply saving for college, a trust fund has a number of advantages, provided you take time to set it up carefully.
Determine exactly what the trust is for and who will benefit from it. You may be passing on an inheritance, protecting a child performer's assets or creating a nest egg for your child to use as an adult. You may be creating a trust to benefit all your children or only one. Each purpose has a specific set of laws and guidelines that govern trust operations, so it's important to be as specific as you can.
Decide how you will fund the trust. You may deposit a specific dollar amount all at once, or you may make deposits over time. Deposits may be uniform or variable. In some cases, it may be important to define who can make deposits -- if anyone may make them or only certain family members.
Think about investments for the trust. While it is best to create an investment plan with a professional, you should know when your child is likely to use the money and how much you'd like to have in the account at that point. It's also important to know how long the child might need funds from the trust and in what increments. For example, a special needs trust might plan for 30 to 40 years of smaller monthly payments, while a college savings plan might have much larger distributions annually for four to eight years.
Decide who will manage the trust as trustee and who will serve as a backup, or successor trustee, in the event that the original trustee cannot carry out his duties. In many cases, the original trustees are the parents, but that is not required and may not even be the best option, depending on the type of trust.
Plan an exit strategy. It's important to know what should happen if the trust is no longer needed or is depleted. For example, if a child chooses not to go to college or receives a scholarship, what happens to the money in his college savings trust? How should trust funds be distributed if a child declines the trust or is no longer living when the trust matures?
Meet with an attorney or use an online legal document preparation service to establish the trust. Once the documents are signed, the trust becomes a separate legal entity and is fully operational.
Funding and Investment
Create an account for the trust at your chosen financial institution. This may be as simple as a bank account, or it might be a brokerage or investment account at a trust company or investment firm. Remember that this account is for the trust and must be kept distinct and separate from all other accounts you might have.
Deposit your first contribution as outlined in the trust. It may be possible to set up additional contributions as automatic transfers from your checking account, just as you might pay a bill. Review this and any other maintenance options with your account administrator.
Invest the trust funds as outlined in the trust document and discussed with your financial advisor. Review the investments on a regular basis -- semi-annually is a good schedule for most people -- to make sure they are performing as anticipated to meet trust needs.
The laws governing trusts can be extremely complicated, and mistakes often nullify or even adversely affect any trust benefit. Make sure your trust documents are created by a qualified legal professional or online document provider.
Keep your trust as simple as possible to avoid any unwanted complications for your child. Keep the trust to a single purpose and thoroughly describe all necessary instructions for its use in the trust document.
Nola Moore is a writer and editor based in Los Angeles, Calif. She has more than 20 years of experience working in and writing about finance and small business. She has a Bachelor of Science in retail merchandising. Her clients include The Motley Fool, Proctor and Gamble and NYSE Euronext.