Parents and grandparents usually have no higher goal than the well-being of their children and grandchildren; but having been young once themselves, they realize that young people don't always have the best judgment about what is best for them. When the elders have accumulated a significant estate, they may rightly worry that their descendants may not know how to deal with such wealth when they inherit it. Some, like the Prodigal Son, may waste it in “riotous living;” others, stripped of the motivating factor of the need to make a living, may not live up to their potential.
Enter the incentive trust, an estate planning device which allows people (grantors) to provide for their loved ones (beneficiaries) while ensuring the money is properly managed by a trustee, and attaching certain strings to its distribution.
Incentive trusts are structured to motivate certain types of behavior and discourage others. It's common for grantors to use the trusts to reward accomplishments they hope for their descendants to achieve, such as maintaining a certain grade-point average in college, graduating with a degree, or pursuing graduate-level education. If the beneficiaries reach whatever the desired milestone may be, they receive a distribution of funds from the trust.
Many grantors use trusts to pay for their children's or grandchildren's education, rather than (or in addition to) rewarding the beneficiaries themselves with payments for achieving educational milestones. In an age where the cost of higher education is rising more rapidly than almost any other expense, the prospect of graduating debt-free from the university of one's choice is a significant incentive.
Incentives can be attached to actions far beyond education. A trust can “reward” a beneficiary for getting married, pursuing a certain type of career, buying a home, or even remaining clean and sober for a specified period. An incentive trust can encourage charitable giving through a donor-advised fund or charitable foundation, or encourage saving by making distributions that match the beneficiary's deposit into a savings account.
There are negative incentives, as well: a trust may specify that a beneficiary will receive distributions unless they engage in certain behavior, such as drug use, or lavish spending.
In short, grantors can use incentive trusts to both provide for loved ones and encourage what they see as positive behavior that is good for their children and grandchildren. It sounds like a win-win situation. What could possibly go wrong?
A few things, as it turns out. In order to administer and enforce, an incentive trust needs to be specific. For instance, if distributions are made for educational needs, does that mean tuition only? Room and board? A semester abroad? However, flexibility is generally desirable in estate planning documents, so that the estate plan can continue to function even if laws and needs change. There may be a real conflict between specificity and flexibility.
Grandpa may be a lawyer who wants to encourage his four grandchildren to pursue higher education. Three of them wanted to anyway, and they know they will receive distributions from the trust for doing so. The fourth has always struggled with school, but is a gifted carpenter. A too-specific trust might rule out distributions for grandchildren in trade school, dissuading that grandchild from pursuing the career that was right for her. A more flexible one might have rewarded her, but been less clear on what constituted "higher education."
In addition to the tension between specificity and flexibility, there is the moral issue of exercising control over people from the grave. Yes, the grantor may want to perpetuate certain family values: education, remaining within one's faith; charity. These seem laudable on their face. Yet what seems more like an incentive “carrot” to the grantor may seem like a punishing “stick” to the beneficiary.
This may have multiple effects. Even if he or she complies with the trust's directives, a beneficiary may bristle and chafe under these strictures, and harbor resentment toward a once-loved grantor. A beneficiary who strongly disagrees with a directive, such as to marry within his or her faith, may feel forced to make a choice between love (and his own independence) and money.
Certain restrictions in an incentive trust may face legal scrutiny, as well. If a restriction (such as on who a beneficiary may marry) is challenged as violating public policy because it unfairly limits important freedoms, the restriction may be overturned. In that case, the grantor's effort in creating the restriction will have not only been for nothing, but will surely have earned the bitterness and resentment of those he or she was trying to “protect.”
None of this is to say that parents and grandparents shouldn't use the prospect of an inheritance to motivate certain conduct or choices, but there may be wiser ways to do so. No one is entitled to an inheritance. If you don't like your heirs' life choices, feel free to disinherit them, but don't hold the threat of disinheritance over their head like a sword. If you do choose to have a trust to encourage certain behavior, consider a so-called “principle” trust which promotes certain values, but gives a trustee more flexibility to decide whether a distribution should be made.
To be sure, “He who pays the piper calls the tune.” But unless you want your children and grandchildren to dance unhappily, or even angrily, be very deliberate about the music you choose. To learn more about how to protect your heirs' wealth and your family values while preserving family harmony and happiness, we invite you to contact us to schedule a free initial consultation.