With the U.S. trust and estate services industry reaching $257.7 billion in 2024, it’s clear that trust accounting is a rapidly growing sector, offering significant opportunities for accounting firms.

But with these opportunities comes a tremendous responsibility. When you’re managing trust accounts, you’re dealing with your clients’ money or the money of their clients (beneficiaries). This means you’re entrusted not just with accurate record-keeping, but also with safeguarding funds that are often tied to critical life events, such as real estate transactions, legal settlements, or estate planning.

The stakes are high. Mishandling trust funds, failing to adhere to compliance standards, or overlooking details can lead to serious legal consequences, reputational damage, and a loss of client trust. That’s why mastering the ins and outs of trust accounting is essential for any firm looking to expand its services in this area.

In this guide, we’ll explore all you need to know about trust accounting, from setting up and managing client trust accounts to key tools and best practices that ensure accuracy, compliance, and transparency.

What is Trust Accounting?

Trust accounting refers to the process of managing funds that one party (the trustee) holds on behalf of another party (the beneficiary). This could be money held in an escrow account for a real estate transaction, funds placed in trust for an estate, or money set aside in a client trust account for a legal case.

Trust funds are specifically designated amounts of money that belong to someone else. As the trustee or accountant responsible for managing these funds, you have a legal obligation to keep them separate from the trustee’s operating funds. This separation is crucial because it ensures the beneficiary’s money is protected and properly accounted for.

Industries that commonly use trust accounting include:

  • Legal Services: Lawyers often hold client funds in trust accounts for purposes such as settlements, escrow, or retainer fees.
  • Real Estate: Escrow accounts are used to hold funds during property transactions.
  • Estate Planning: Executors manage client funds held in trust for beneficiaries.
  • Financial Services: Investment advisors may hold client funds in trust for specific purposes, such as investments or savings.

What makes trust accounting different from standard bookkeeping is the nature of the funds being managed.

While you can handle standard bookkeeping for your clients, i.e tracking their income, expenses, and financial transactions, trust accounting requires you to act as (or on behalf of) a custodian of funds that are not the trustees. This means strict legal and regulatory compliance is required. You must ensure that trust funds are kept separate from the trustee’s operating funds, are fully documented, and are reported in accordance with industry regulations.

This additional level of responsibility and oversight makes trust accounting more complex than standard bookkeeping.

Key Components of Trust Accounting

Here’s a breakdown of the essential components of trust accounting:

Client Trust Accounts (CTA)

A Client Trust Account (CTA) is a separate bank account where client funds are held in trust. These accounts are distinct from the trustee’s operating accounts and are used exclusively for transactions on behalf of the beneficiary. It’s essential that you open and maintain a dedicated account for each beneficiary’s trust funds, keeping their money separate from the trustee’s. You should also regularly monitor the balance of each trust account to ensure it matches the beneficiary’s records.

Record-Keeping

Accurate and detailed record-keeping is one of the most critical aspects of trust accounting. You must document every transaction in the trust account, whether it is a deposit, withdrawal, or disbursement. These records should include the date, the amount, the purpose of the transaction, and any related documentation.

You also need to maintain a ledger for each beneficiary’s trust account. This ledger should clearly show all deposits, withdrawals, and the current balance. Comprehensive and accurate record-keeping ensures transparency, protects your firm from potential disputes, and satisfies regulatory requirements.

Compliance & Regulations

Trust accounting is heavily regulated to protect beneficiaries and ensure funds are handled appropriately. Different jurisdictions have specific regulations governing the management of trust funds, and failure to comply can result in serious legal consequences. For instance, the California State Bar has its own rules, and North Carolina has its own.

You’ll need to stay updated on industry regulations such as the American Bar Association (ABA) guidelines for legal trust accounts or other local laws governing trust fund management in your area.  Compliance with these regulations is crucial for maintaining a trustworthy and legally sound practice.

Bank Reconciliations

Regular bank reconciliations are vital to ensure that the trust accounts match your records. This means comparing the balances shown in the beneficiary trust account ledgers with the actual balances in the bank. Reconciliation helps ensure that no funds are missing or misallocated, and it also allows you to catch errors early, before they turn into larger problems.

Segregation of Funds

Segregation of funds refers to the practice of keeping beneficiary funds separate from the trustees’ operating funds, as well as ensuring that each beneficiary’s funds are separate from those of others. This segregation is vital to maintaining clear records, avoiding conflicts of interest, and complying with legal and regulatory requirements.

For example, if a beneficiary deposits money into a trust account, that money cannot be mixed with the trustee’s operating account or used for anything other than the beneficiary’s specific needs. Any withdrawal or disbursement must be carefully documented, and funds must not be used for anything that the beneficiary has not authorized.

Compliance & Regulatory Requirements for Trust Accounting

Trust accounting is heavily regulated to ensure beneficiary funds are properly managed and protected. Here’s an overview of the key compliance and regulatory considerations for managing trust accounts:

State & Federal Regulations

A combination of federal and state laws governs trust accounting. While federal regulations set broad standards, each state has its own specific rules that can vary widely. ​

Case in point, the California Probate Code §16062 requires trustees to provide beneficiaries with an annual accounting of the trust’s finances. While the North Carolina Rules of Prof. Conduct 1.15-2 & 1.15-3 states that trust funds must be deposited in designated trust accounts, and lawyers (and the accountants who help them) must keep client-by-client ledgers, three-way reconciliations, and retain all records for six years.

So, it’s important to familiarize yourself with the specific laws in your state to ensure compliance.

Interest on Lawyers’ Trust Accounts (IOLTA)

IOLTA programs are a significant aspect of trust accounting. These programs let lawyers pool client funds that are nominal in amount or held only briefly—amounts too small to earn net interest for the individual client or can’t be ethically retained by the client—in an interest-bearing trust account. The bank then sends the interest (after deducting allowable fees) to the state’s IOLTA authority, which uses it to support civil legal aid and other access-to-justice initiatives.

Every U.S. jurisdiction operates its own IOLTA program, and participation rules vary: most are mandatory (lawyers must place eligible funds in IOLTA), a few are opt-out (like Nebraska, Alaska, and Kansas) or voluntary, like Virgin Islands.

States also differ in record-keeping details, eligible banking institutions, and interest rate comparability rules. Understanding your state’s specific IOLTA requirements—and when a separate, client-specific trust account is required instead—is essential to staying compliant.

Financial Reporting Requirements

Trust accounting comes with specific financial reporting requirements that ensure funds are properly accounted for and compliant with applicable laws. This typically includes the need to produce regular reports detailing all deposits, withdrawals, and disbursements made from trust accounts. These reports should be clear, accurate, and available for review by both clients and regulatory bodies.

In addition to general record-keeping, you may also be required to submit periodic audits or financial statements to verify that trust funds are being managed in accordance with the law. These reports must include detailed information about the balance of each beneficiary’s trust account and any activity related to the funds held in trust.

Penalties for Non-Compliance

Mishandling trust accounts or failing to comply with regulatory requirements can have serious consequences. The penalties for non-compliance can include:

  • Legal Penalties: Failure to comply with trust accounting regulations can result in fines or legal action, especially if it involves misappropriation of funds or fraud.
  • Loss of License: Regulatory authorities can revoke or suspend your professional license if you fail to adhere to trust accounting laws. Case in point, over 1,700 California lawyers were suspended for failure to comply with new trust laws.
  • Reputation Damage: Mishandling trust accounts can severely damage your firm’s reputation, leading to loss of clients, trust, and business.
  • Criminal Charges: In extreme cases, mishandling trust funds can result in criminal charges, especially if the funds are used for unauthorized purposes or are misappropriated. For instance, a former Illinois accountant was sentenced to 16 years for $77 million trust-fund fraud.

Step-by-Step Guide to Trust Accounting

Step 1: Setting Up a Trust Account

The first step in trust accounting is to set up a dedicated Client Trust Account (CTA) for each beneficiary or project. This account should be separate from the trustee’s operating account and must be clearly labelled as a trust account. Make sure to choose a bank that understands the requirements of trust accounting and can provide statements that clearly distinguish between trustee funds and beneficiary funds.

When setting up the account, ensure you have proper documentation outlining the terms and conditions under which the account will be managed. You may need to submit client agreements, retainer contracts, or other legal documents to ensure the account is fully compliant with the law.

Step 2: Recording Transactions Correctly

Accurate record-keeping is at the heart of trust accounting. Every transaction within a trust account, including deposits, withdrawals, and disbursements, must be recorded in detail. These records should include the date, amount, reason for the transaction, and any related documentation (e.g., invoices, contracts, or receipts).

You must maintain a separate ledger for each client that clearly tracks their trust funds. These ledgers should include a record of all deposits, withdrawals, and current balances. Additionally, every transaction must be categorized according to its purpose (e.g., retainer payment, escrow deposit, legal fees).

Step 3: Conducting Regular Bank Reconciliations

Regular bank reconciliations are crucial to ensure that the balances in your trust accounts match the bank’s records. This step helps identify errors, discrepancies, or potential fraud early.

A bank reconciliation compares your internal records with the actual balance in the trust account to make sure everything aligns. Depending on the state you’re in (e.g Texas and North Carolina), you might need to do a three-way reconciliation as it’s mandatory in some jurisdictions.

You should reconcile the trust accounts at least once a month to ensure everything is accurate and up-to-date. It’s also a good idea to conduct reconciliations immediately after any large transactions or withdrawals to identify any issues in a timely manner.

Step 4: Generating Trust Accounting Reports

You’ll also need to create trust accounting reports. These reports should detail all transactions for each beneficiary’s trust account, including deposits, withdrawals, and current balances.

Reports should be clear and easy to understand, both for the beneficiary and for regulatory purposes. Common reports include:

  • Transaction Reports: A detailed list of all transactions within the trust account.
  • Balance Reports: A summary of the current balance in each trust account, as well as any outstanding transactions or fees.
  • Reconciliation Reports: A record of bank reconciliations and any discrepancies that were resolved.

Step 5: Closing and Disbursing Funds Properly

The final step in trust accounting is properly closing and disbursing funds. Once the purpose of the trust account has been fulfilled, you must ensure the funds are disbursed according to the beneficiary’s instructions and any applicable agreements.

Before closing a trust account, verify that all obligations have been met and ensure all funds are properly accounted for. Disburse any remaining funds to the client or relevant parties, and ensure that proper documentation is provided for all disbursements.

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Trust Accounting Best Practices

Use Dedicated Trust Accounting Software for Compliance and Automation

Instead of using generic tools, use software designed specifically for trust accounting, like TrustBooks or Clio, to streamline processes and maintain compliance. These tools help automate tasks like reconciliations, generate accurate reports, and provide audit trails.

Reconcile Trust Accounts Regularly To Avoid Discrepancies

To maintain the integrity of trust accounts and meet regulatory body requirements, perform monthly reconciliations. This practice helps identify discrepancies early, preventing potential compliance issues.

Keep Detailed and Organized Records of All Trust Transactions

Keep comprehensive records of all transactions within trust accounts for transparency and to simplify audits. Each entry should include transaction date, amount, transaction purpose, client identification, supporting documentation (e.g., invoices, agreements), etc.

If your clients are in different states, they may have specific rules about how long trust funds can be held, or whether certain types of funds (such as retainer fees) can be used for immediate expenses. Be sure to stay informed about these regulations to ensure you’re always in compliance.

Separate Beneficiary Funds From Business Funds To Maintain Compliance

Always maintain clear segregation between beneficiary trust funds and the trustee’s operating funds. This separation is not only a best practice but also a legal requirement in many jurisdictions. Commingling funds can lead to severe penalties and issues.

Properly Manage Disbursements from Trust Accounts

To avoid making disbursement mistakes, set up internal controls, such as requiring approval for larger disbursements and obtaining the beneficiary’s written consent before making any payments. Also, always document the purpose, amount, and recipient of each disbursement, along with supporting paperwork.

Choosing the Right Trust Accounting Software

When managing trust accounts, it’s essential to be accurate and precise. Accounting Automation plays a crucial role in achieving this. It reduces the likelihood of human error, speeds up time-consuming tasks, and ensures that your records are always up to date. So any accounting automation tool you choose should have automation capabilities to help in the following ways:

Automated Transaction Tracking

Trust accounting involves frequent transactions, whether it’s deposits, withdrawals, or disbursements. Automated transaction tracking ensures that every financial movement is captured accurately in real-time. This reduces manual data entry, minimizes errors, and ensures that all trust funds are recorded as soon as they are transferred or allocated. It also helps ensure compliance with reporting requirements by maintaining a clean transaction history.

Bank Reconciliation

Bank reconciliations are one of the most important tasks in trust accounting. Reconciliation ensures that the balances in your trust accounts match your records with the bank’s statements. Trust accounting software should include bank reconciliation capabilities to automatically compare your internal records with bank statements, highlight discrepancies, and help resolve them quickly. This feature simplifies a typically tedious and error-prone task, ensuring that your trust accounts are always accurate and compliant.

Custom Reporting for Audits

Audit readiness is a critical aspect of trust accounting. Your software should offer custom reporting tools that enable you to generate detailed and transparent reports for audits. These reports should include all transactions, balances, and any discrepancies found during reconciliations. Being able to quickly generate clear and accurate reports makes audits much easier, ensuring that your trust accounting is transparent and compliant with regulations.

Compliance Safeguards

With trust accounting being heavily regulated, having built-in compliance safeguards is essential. Look for software that automatically updates with changes in industry regulations (though you should still monitor updates), alerts you to potential compliance risks, and ensures that your practices are in line with state and federal requirements. Compliance features might include automatic reminders for reconciliation dates, checks to ensure no funds are commingled, and tools to ensure correct documentation for every transaction.

Use an Accounting Practice Management Software

In addition to trust accounting software, accounting practice management software, such as Financial Cents, can help streamline your entire accounting firm’s operations. It is an all-in-one practice management software that helps firms get organized, automate manual processes, and stay on top of all deadlines.

Here’s how Financial Cents can help:

  • Workflow dashboard which shows every project, owner, status and due date in one place.
  • Client portal & secure file-sharing, which lets you request documents from clients and allows them to upload the documents directly into the client portal. It also lets you set automated follow-up reminders.
  • Capacity planning, which shows who’s overloaded and who can take on more work.
  • Store engagement letters, e-signatures, and client communications right beside the job, creating a tidy audit trail.
  • Unlimited number of clients for free so that you can scale with no extra costs.

Why don’t you try it out today? We have a 14-day free trial for you.

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