A trust fund for kids can be a useful financial tool that helps set your children up for success. Inherited wealth can sometimes be spent unwisely due to immaturity or lack of financial education. Distributing your assets to your kids through a trust gives you greater control over how the money is used, ensuring generational wealth isn’t wasted. A trust fund for kids can also be put in place to provide for children with special needs. However, the trust may not have the intended effect if it’s set up improperly. It’s important to avoid common pitfalls when securing your child’s future with a trust. Here are common mistakes parents make when setting up a trust fund for kids.
Setting Up a Trust Fund for Kids: Common Pitfalls
Not Understanding the Different Types of Trust Funds for Kids
There are two main types of trusts—revocable and irrevocable. A revocable trust can be changed after it’s established, allowing for greater financial flexibility. Irrevocable trusts, on the other hand, usually can’t be amended once they’re set up. However, they often provide more protection from lawsuits and creditors while offering certain tax benefits.
For example, a generation-skipping trust enables you to pass down money to your grandkids to avoid estate taxes. If you’re setting up a trust for a disabled child, a special needs trust can help ensure they remain eligible for certain government benefits. Figuring out which trust fund for kids is right for your family is a crucial step in the process, especially since irrevocable trusts cannot easily be modified.
Choosing the Wrong Trustee
Parents setting up a trust fund for kids must choose a trustee to manage and disburse the assets according to the rules they set. The trustee will have control over your wealth, so it’s important to choose someone responsible who will invest it wisely. Although you love your family members and friends, it’s possible that they may not be the best choice for this role. Naming a relative as a trustee can put them in the awkward position of having to deny your child access to funds at times. Mixing family and finances in this way could put a strain on your child’s relationships.
Choosing a professional fiduciary like a bank to be the sole or co-trustee may be a better move depending on your circumstances. As a neutral third party with significant financial expertise, your bank can help ensure your wealth is protected and distributed according to your wishes. However, financial institutions usually charge management fees, which is something to consider. Before you make any decisions, be sure to carefully research and weigh your options.
Setting Overly Rigid Rules
Trust funds can be used to incentivize your kids to make good decisions. Some parents choose to set rules that reward positive behavior. For example, a child who maintains a great GPA in college may be allowed access to a bigger portion of the funds at an earlier age. You can also tie disbursements to major life milestones, such as getting married or buying a house. However, setting rules that are too rigid could prevent your child from accessing needed funds. After all, life can take many twists and turns, so it may be unwise to tie their inheritance to specific life benchmarks like marriage or college graduation.
It’s important to consider your child’s abilities and goals when setting guardrails. In some cases, it may be better to schedule disbursements according to your child’s age instead of their specific life stage. This setup ensures that your child is mature enough to handle the financial responsibility of managing their inheritance while providing greater flexibility. Another option is to require your adult child to meet with a financial advisor before gaining control of the funds. Your lawyer can help you structure the trust with rules that will set your child up for financial success without being overly strict.
Failing to Consider the Impact on Financial Aid
Parents creating a trust fund for kids must also consider the impact on college scholarships and financial aid. If your child is named as the beneficiary, the trust fund will typically be counted as one of their assets. Depending on the value of the trust and how it’s structured, it could affect their eligibility for financial aid. It’s important to consult your lawyer to determine how distribution rules and other factors could impact your child’s education.
Trust Funds for Kids Can Be Complicated
Although trust funds are a valuable financial planning tool, they can be quite complex. That’s why it’s important to consult lawyers and other experts you trust during the setup process. Taking the time to fully understand and carefully consider your options will prevent you from making costly mistakes.
Vicky Monroe is a freelance personal finance writer who enjoys learning about and discussing the psychology of money. In her free time, she loves to cook and tackle DIY projects.
