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The Biggest Mistake Parents Make When Setting Up a Trust Fund

The Biggest Mistake Parents Make When Setting Up a Trust Fund

February 16, 2024

You want the best for your children, both now and in the years ahead. Establishing a trust fund can grant them the financial security that you want for their future. Unfortunately, setting up a trust fund can come with a lot of complications from appointing a trustee to funding the trust. 

The question is: What is the biggest mistake parents make when setting up a trust fund? 

Here is what you need to know to avoid issues for your child’s financial future. 

The Biggest Mistake When Setting Up a Trust Fund 

What is the single biggest mistake that parents tend to make when attempting to provide for the financial futures of their children? The answer may surprise you as it could be easily avoided: lack of proper planning. 

Trusts can be complex with lots of moving pieces, which means you need to consider all aspects of how they are set up and how they will function in the future. Changing a trust later on can be extremely difficult or impossible, especially in the case of an irrevocable trust. 

If you want to make certain that your child’s financial future is secure, you should work with a professional from the outset. A professional can help you with all of the legal aspects of designing a trust that works for your unique familial situation. Not only that, but they can ensure you do not miss anything important that could negatively impact its future financial benefits

What to Consider and Plan When Creating a Trust Fund 

If you know that lack of planning is the biggest mistake parents make in trust fund creation, here are some ways that you can combat this. 

1. Choose the Right Type of Trust

The first thing you need to consider is the type of trust you want to establish for your kids. There are no easy one-size-fits-all solutions for trust funds. Some people will want to set up a revocable trust that is more easily altered to add beneficiaries and contribute to funding over time. Others may want an irrevocable trust that is far more difficult to modify but comes with additional benefits.  

You can set up trusts to issue funds slowly, spread out over a lifetime. Others may want to give their children the full trust amount at the outset so that they can use it to invest in a business, buy a house, or pay for college expenses. 

There are also other types of trusts to consider including charitable trusts. These often secure a guaranteed source of income for your child on an ongoing basis while also benefiting from the tax advantages of donating a sum to charity

The choice is yours and a professional can help pinpoint the right method for your family. 

2. Appoint a Trustworthy, Competent Trustee

Who will handle the details, payout, and earnings from the trust? It can be tempting to select a responsible child to oversee the trust funds for everyone, but a family member might not be the wisest choice. They can be easily influenced by family dynamics and may hinder the payout of the trust. 

Instead, you should consider appointing a trusted professional for this crucial role. They have no stake in family drama and can simply do their fiduciary duty to oversee the trust in the way you have outlined for future payouts. 

3. Calculate Your Child’s Financial Needs 

As you think about setting up a trust, you should take an honest inventory of your child’s financial needs before landing on a final dollar amount. Both under-funding and over-funding a trust can spell problems for them in the future. Take time to think about what you designed this trust to help them with and make a decision about how much they will need. 

One issue that is more common than you may think is forgetting to fund the trust. After spending time and money to set up the legal framework, some individuals subsequently forget to transfer assets and funding into the trust. Don’t let this mistake hinder you from helping your child!

4. Define Clear Terms and Conditions 

Will it be simple for your child to access the funds in the trust and use them the way you designed? Setting the terms and conditions on the trust can minimize the risk that your child will squander the money you set up for them. Be specific about how funds are to be dispersed and ultimately used once your child comes of age.

Proper verbiage may even help you make adjustments to irrevocable trusts, whereas those changes would not be possible otherwise. For something like a charitable remainder trust, you can also work in additional flexibility by naming a donor-advised fund as the charitable beneficiary. This way, you don’t need to commit to a charity right away and can choose one down the road.

5. Keep the Trust Up to Date 

If you established a revocable trust that can be changed, you need to ensure that it remains as up-to-date as possible. In the event of the death of a partner, child, or other beneficiary, you may need to reassign some duties. Divorce can also complicate the issue of a trust fund, especially if you remarry and want your blended family members to benefit from your wealth planning. 

Consider meeting with a professional to assess whether your trust is still meeting your goals, needs to account for new assets, or adequately covers new life changes like birth or death. Every few years, you should audit a revocable trust to make changes as necessary. 

6. Understand Tax Implications

In addition to updating your trust for life changes, you should also stay abreast of tax implications for your trust. For example, distributions will need to be reported on your beneficiary’s annual tax return.

It’s also crucial to fully understand all the tax rules and exemptions that you and your trust can benefit from. One savvy move is to sell real estate within a charitable remainder trust, which would make that sale exempt from capital gains tax.

While there are many tax benefits to establishing a trust, those could change at any moment. Take advantage of the current laws and establish a trust now, evaluating it regularly to determine what would be most advantageous for your beneficiaries.

Let Magellan Help You Establish Your Trust

Are you ready to start planning for a trust fund for your children? Magellan can help you with our comprehensive estate, financial, legal, and tax planning. We can guide you through the process with our one-stop-shop approach to your ongoing financial management. 

Reach out to us today to learn more about how we can help you plan for the future! 

This material provided by Kevin Meaders was written by Axle Eight, a non-affiliate of Magellan Planning Group and Cetera Advisor Networks LLC.