If your estate planning goals include distributing your wealth while also encouraging specific behaviors or achievements among your heirs, using an incentive trust might be right for your plan.
Unlike a traditional trust, which distributes assets according to a set schedule or upon a beneficiary reaching a certain age, an incentive trust includes specific conditions that must be met before distributions are made. These conditions can align with your values, such as pursuing higher education, maintaining gainful employment, engaging in charitable work or avoiding destructive behaviors like substance abuse.
Setting Guidelines
Essentially, an incentive trust sets guidelines for how a beneficiary becomes eligible to benefit from the trust. Distributions can, for instance, be contingent on a beneficiary graduating from high school, earning certain grades, or enrolling in or graduating from college.
Then again, perhaps you’re more concerned about a beneficiary’s physical well-being than his or her intellectual one. In this case, you might structure an incentive trust to disallow payouts if the beneficiary indulges in harmful or illegal behavior, such as abusing alcohol or using illegal drugs. Going this route will, however, require that you appoint a trustee who knows the issues and who can monitor the beneficiary’s activities and enforce the provision.
From a business perspective, an incentive trust can include provisions that reward your beneficiary for becoming involved in the family business or mapping out a career path of his or her own. Build in matching charitable donations and you can help the beneficiary develop an appreciation for community service and volunteerism.
Minding the risks
Incentive trusts come with some inherent risks. If the provisions are too restrictive, or simply don’t suit the beneficiary in question, the incentive may backfire.
For instance, say Jane, a 20-year-old college dropout, learns that her Aunt Lucy has provided her with $500,000 in trust. However, Jane can withdraw the trust funds only if she returns to college and earns a bachelor’s degree.
The problem is, Jane never really liked Aunt Lucy, who often scolded her for making bad choices and meddled in her life. And Jane didn’t really like college either. As a result, the trust only furthers Jane’s resolve to never return to college — no matter how much money she loses.
In other cases, the beneficiary may force him- or herself to complete a degree but wind up living an unfulfilled life because he or she had other dreams in mind. Or you might end up “motivating” a beneficiary to work for the family business when he or she really doesn’t want to, which, in turn, could hurt the company.
Communicating with clarity
A big part of making sure an incentive trust will work is clearly communicating with your trustee. He or she should generally have broad discretionary powers because, as time passes, a beneficiary’s circumstances might change. For example, a student might develop learning or other disabilities that prevent him or her from achieving the academic goals set by the incentive provisions.
In general, the trust should provide enough of a safety net that, if the beneficiary fails to achieve the trust’s goals, he or she will still be able to support him- or herself. The incentive provisions can apply to only a part of the trust assets. The trust should also provide for giving some or all the funds to a secondary beneficiary, in case the primary beneficiary fails to meet the stated goals or dies.
If you are a Legacy client and have questions, please do not hesitate to contact your Legacy advisor. If you are not a Legacy client and are interested in learning more about our approach to personalized wealth management, please contact us at 920.967.5020 or connect@lptrust.com.
This newsletter is provided for informational purposes only.
It is not intended as legal, accounting, or financial planning advice.
