How Can I Benefit from an Incentive Trust?

We all know that money is a pretty powerful device. Changes in tax policy incentivize people to save or spend their money in particular ways just so they can keep more of it. Take, for example, electric cars. Electric car sales increased the moment that people received tax breaks for buying them.  

People work hard to make sure they have money in their nest eggs for retirement. In that vein, the government incentivizes people to save more by making sure that the money they put into an IRA or 401(k) could be tax-deductible.  

Parents often use the money to push their kids to make certain decisions. In fact, you must have seen movies, read books, or read news articles about parents directing their children’s behavior by funding or not funding their life choices.  

All of that is to say that the “power of the purse” is powerful indeed. And that extends to the choices people make with regard to who gets their money after they pass away. We’ve all heard stories of parents disinheriting certain family members. Well, in case you are doing your estate planning and do not want to take the drastic step of disinheriting anyone, there is still an alternative – incentive trusts .

The concept of an incentive trust has gained a lot of popularity recently among lawyers and other estate planning professionals. Basically, an incentive trust is a trust that has certain “incentive provisions” that, as you may expect, push people to engage in certain behaviors, confront particular issues, or further an overall perspective on life.  

Thus, the incentive trust provides a financial incentive for the beneficiary to engage in a particular behavior. If the beneficiary engages in that behavior, then he or she will receive money from the trust. When you think about it, this is not too different from promising your toddler ice cream if he behaves in the supermarket (we’re not above bribing our kids, right?).

A trust does not always have specific incentive provisions. Sometimes the trust will include an overall statement about the trust grantor’s worldview or life perspective. Then, the trustee of the incentive trust should be guided by those general life principles.  

For instance, an incentive trust can demand, as a general proposition, that the assets should not be given to a beneficiary if the assets would lead to the beneficiary choosing not to be self-sufficient. One way to accomplish that goal is to set up the incentive trust so it only pays an amount equal to the income beneficiary earns himself or herself. Thus, the more the beneficiary earns in income, the more he or she will get from the trust.

At Doane & Doane, we have a number of clients who worry about leaving too much to their children because it will wind up spoiling them. That concern is genuine because there are many children who live a luxurious lifestyle from the assets they inherited, rather than earning an income themselves. Indeed, it is a worthy goal to ensure that your children are productive citizens and accumulate achievements for themselves. That is what an incentive trust can do.

The world-renown investor Warren Buffet once said that inheritance is perfect if it is “enough money so that they feel that they could do anything, but not so much that they could do nothing.” Those are wise words. Yet, putting that into practice can be somewhat challenging. Lots of questions come up when thinking about what constitutes “enough money” if: 

1. The child is a stay-at-home parent
2. The child is caring for an elderly relative
3. The child is a student
4. The child is disabled
5. The child is unable to find a job because of a depressed economy.

These issues are important to tackle when drafting your trust document. Moreover, it is always a challenge to predict the future, so a trust document should have a little flexibility to take account of special situations that may arise.  

A good way to do that is to have your trustee keep track of measurable factors like tax return figures, medical reports, and the state of the economy, and indicate how distributions should be made in response to those measurable factors. In short, to have a little flexibility in your incentive trust , you need to have some faith in the trustee whom you choose to administer the trust.   

That last point is a great segue into the topic of who you may want to choose to be a trustee. Many times, trust grantors will choose a sibling or friend to serve as a trustee. But there is a good chance that children and grandchildren will outlive siblings and friends of the grantor. Thus, you may want to think about having a corporate fiduciary – a company – serve as a successor in the event that the primary chosen trustee cannot administer the trust.  

You may think that there must be a limit on the types of incentives that you can insert into a trust. But, if you believed that, you would be wrong. The variations on the incentives you could insert into a trust are only limited by your own creativity. While it might not be an optimal choice, you could condition a distribution to a beneficiary based on whether that beneficiary becomes a lawyer, or a doctor, or achieves a certain level of education.  

It is freeing to have that kind of control over how your money is distributed, however, tread carefully here. As you consider incentive provisions, be aware that the promise of money does not always change behavior. If, for example, you have a child suffering from addiction, then offering trust money based on that person not using the drug of choice will likely not be effective, and may create worse problems, financially and otherwise, for that child. So, as you craft an incentive trust, consider how best to help your beneficiaries.

At Doane & Doane, we have the resources and experience to help you understand all aspects of an incentive trust and other estate planning tools. Doane & Doane’s Palm Beach estate planning attorneys can help you secure your family’s future. 

If you think it is now time to get started on your own estate plan, or want to learn more about incentive trusts, give us a call at 561-656-0200.

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