Trust for kids: How to create one & pitfalls to avoid

As a parent, securing your child’s future financial well-being is likely your top priority. One way to make sure they have the resources they need down the line is to create a trust fund. But setting one up can be complex and confusing. 

 

Where to start? What are you responsible for? What funding sources can be used and what are the pitfalls? Here’s everything you need to know about trusts for kids, including the different types available, steps to set one up, and mistakes to avoid.

 

The information provided is not intended to be investment, tax or legal advice – nor does it claim to be comprehensive. Speak to a professional if you’re unsure about whether investing is right for you. We do not endorse any third parties referenced.

 

What is a trust fund?

A trust fund is a type of financial account set up for a child’s benefit. It might be to pay for their education, support their future financial needs or provide income during their lifetime. Trust funds are often used as a financial safety net and support for a child, perhaps during a period when they’re unable to manage their finances on their own.

 

The assets placed in a trust fund vary. Typically, they’ll include cash, stocks, bonds or real estate. The funds in the trust are managed by a trustee legally appointed by the child’s parent or guardian The trustee is responsible for making investment decisions, managing the assets and distributing the money to the child under the terms set out in the trust agreement. 

 

Trust funds can also have tax advantages. It depends on how they’re structured and managed. 

 

 

 

Types of trusts

There are several different types of trusts. Each has its own unique features and benefits. Choosing the right kind of trust depends on your specific financial goals and circumstances. Here are some of the common ones:

• Revocable living trusts: This type of trust can be changed or revoked by the person who created it (known as the grantor) during their lifetime. Assets placed in a revocable living trust are managed by a trustee and can be distributed to beneficiaries as directed by the grantor.

• Irrevocable trusts: An irrevocable trust cannot be changed or revoked once it’s been created but may come with tax benefits and asset protection. Once the trust is set up and the assets are transferred, you no longer have control over them. It’s best to seek legal and financial advice if you’re looking into creating an irrevocable trust. 

• Testamentary trusts: These are created through your will and come into effect after your death. Testamentary trusts can be used to manage assets for children, provide for a surviving spouse, or support charitable organizations.

• Special needs trusts: A special needs trust is designed to provide for someone with disabilities without jeopardizing their eligibility for government benefits like Medicaid or Supplemental Security Income (SSI).

• Charitable trusts: These trusts are set up to support charitable organizations or causes. They may also come with tax advantages. 

• Spendthrift trusts: A spendthrift trust is designed to protect assets from creditors or other legal judgments. If you create a spendthrift trust for your child they won’t be able to access the money directly. Instead, it gets paid out regularly by a trustee.   

Reasons to create a trust fund for a child

• Asset protection: Trust funds can protect assets from creditors or legal judgments (from lawsuits or bankruptcy, for example).

• Financial security: A trust fund can be used to ensure your child has financial security throughout their life. You can set up the trust so your child receives funds at intervals or on reaching certain milestones. Like finishing college or buying their first home.

• College education expenses: A trust fund can provide for your child's college education. As well as tuition, it could cover the cost of books and accommodation.

• Tax benefits: Trust funds can provide tax benefits for you as well as your child. For example, certain types of trusts can reduce estate taxes, income taxes, or gift taxes.

• Control of assets: Even after your death, as grantor (creator) of a trust you keep control. This can be useful for making sure assets are distributed as you wish and not subject to disputes among family members. 

Related: Gifting money to children

 

 

How to create a trust for a child

Creating a trust for a child can be a complex, legal and financial process. Here are some general guidelines to follow:

 

• Determine your goals

• Choose a trustee

• Draft the trust document

• Fund the trust

• Name the beneficiary

• Determine distribution terms

• Review and update

• Provide instructions

Determine your goals

Decide why you want to create a trust and what you want it to achieve. This will help you choose the type of trust that suits your purpose and the terms you want to include.

 

Choose a trustee 

Select a trustee to manage the trust assets and distribute its funds. A trustee can be a family member or friend or a professional, such as a bank or attorney. 

 

Draft the trust document

Work with an attorney to draft a legal document outlining the terms of the trust and the assets you’ll be placing in it. You’ll also want to include the distribution schedule as well as any special instructions.

 

Fund the trust

Transfer cash, stocks, bonds or real estate into the trust. This may involve legal paperwork to make sure it’s done correctly.

 

Name the beneficiary

Choose who gets to be the trust’s beneficiary. This can be one or more children and the trust can specify how funds are to be distributed between them. 

 

Determine distribution terms

Decide on the terms for distributing the trust funds. For example, at what age can your child access? Is there any purpose for which you want the funds used? If so, specify these along with any conditions that must be met before funds can be distributed. 

 

Review and update

Things change in life. Your estate plan needs to keep pace with those changes. Review and reassess the trust regularly (annually at least) so you can be sure it still meets your goals and reflects your wishes. Reassess things like: who you’ve chosen to be trustee — are they still in good mental and physical health? Check your list of beneficiaries.  Do you need to update these? Have there been any births or deaths in the family?

 

Provide instructions

It’s important you give instructions to your family and the trustee about the existence of the trust and its terms. You should also make sure they have clear instructions about what to do if you become ill or die. This ensures your wishes will be carried out and the trust properly managed. 

 

Pitfalls to avoid when creating a trust for a child

A trust can be a powerful estate-planning tool but there are pitfalls you want to avoid. Here are a few mistakes people make when creating a trust for a child.

 

• No contingency plan: Make sure you plan for contingencies like divorce, remarriage or the death of a beneficiary or trustee. Without proper planning, the trust may not be able to achieve the goal you intended for it. 

• Choosing the wrong trustee: Picking the wrong trustee can lead to conflicts of interest or mismanagement of trust assets. Be sure you choose a trustee who has the skills, experience and integrity to manage the trust properly.

• Creating an overly restrictive trust: Too many rules and regulations around the trust can limit your child’s ability to access the funds and achieve their goals. It’s important to strike a balance between protecting assets and providing flexibility.

• Failing to consider tax implications: When it comes to taxes, trusts can be complex. There’s estate taxes, gift taxes and income taxes to consider. Work with a qualified tax advisor to understand the tax implications and minimize tax liabilities for you and your children. 

• Not reviewing the trust regularly: A trust that’s not regularly reassessed and reviewed may not adequately reflect changes in your family situation, the goals you want it to achieve or the legal and financial environment.

• Failing to inform family members: Not providing instructions to family members and letting them know of the trust’s existence can cause disputes, misunderstandings and legal issues down the road. 

• Not considering your child’s needs and goals: Don’t forget your child’s perspective when creating a trust. What are their needs and savings goals? Does the trust you’re creating meet these? Without considering your beneficiary’s point of view, the trust may not serve its purpose. 

How GoHenry can help

GoHenry is a great tool for parents wanting to teach their kids about money management and financial responsibility. Available for children aged 6-18, it’s a prepaid debit card that comes with a companion app for parents. So while your kids get a taste of financial independence, you get peace of mind. 

 

You can pay in their allowance, set limits and monitor their spending — you get alerted in real-time every time they use their card. Plus, our in-app Money Missions, teaches them smart money skills that’ll set them up for a financially healthy future. Through fun, bite-sized interactive games and quizzes they’ll learn everything from budgeting to investing, and saving to stocks and shares.

 

 

The information provided is not intended to be investment, tax or legal advice – nor does it claim to be comprehensive. Speak to a professional if you’re unsure about whether investing is right for you. We do not endorse any third parties referenced.