What Are Incentive Trusts, and Should You Use One?

Husband and wife discussing investment plans

Parents, grandparents, and benefactors often want to pass down more than money to their heirs. You may want to instill a good work ethic, or ensure that the next generation is set up for success. Incentive trusts are estate planning tools that can help you do that. However, if they are not written carefully, they can also cut your children off from funds when they need them most.

What is a Family Incentive Trust

When you have worked for your wealth you may worry that your children or grandchildren may not have the same drive because of their comfortable lifestyle. You may want to manage their inheritance in a way that teaches responsibility and hard work. An incentive trust (or family incentive trust) can help you do that. It is a type of trust that sets out conditions beneficiaries must meet before receiving distributions. Money could be distributed to heirs:

  • When benchmarks are met (like graduating from college)
  • During specific periods of life (like while enrolled in college or caring for young children)
  • When negative behaviors are avoided (like maintaining sobriety)
  • Based on their own income

These conditions can encourage your beneficiaries to make good choices and reward them for their own success.

How to Choose Incentive Trust Language

The specific incentive trust language used is crucial to allowing the document to function properly. Think of it like a contract with your children. You are promising that if they accomplish certain tasks, you will give them additional inheritance. The more concrete, measurable, and specific these behaviors are, the easier it will be for your trustee and beneficiaries to know whether they are being met. Your trust could allow for disbursements:

  • “Upon graduation with a Bachelor’s Degree or vocational equivalent” (rather than “If they attend college”)
  • To match beneficiaries’ gross income on tax return or W-2
  • Upon receipt of each pin or coin awarded in Alcoholics or Narcotics Anonymous programs
  • As a gift upon their wedding if married at age 25 or older
  • Based on volunteer hours worked for a desired charity

This kind of language removes ambiguity and makes it easy for everyone to understand when and how distributions will be made. You may also want to include an explanation for why these terms are included, and what lesson you are trying to teach your children or grandchildren.

What Happens if Beneficiaries Don’t Meet the Requirements

Most trusts include provisions for what should happen to any remaining balances after the distributions are made. You might direct that the funds be reinvested and used to provide supplemental income to beneficiaries in the future. Or you might direct that the trust be closed and the balance distributed to specific charities or foundations.

But what if your beneficiaries don’t meet the requirements of your family incentive trust for entirely justifiable reasons?

  • They choose to be a stay-at-home parent of a special needs child
  • An accident or illness prevents them from working
  • A disability extends their education or limits their earning capacity

Most parents and grandparents don’t intend to punish beneficiaries for circumstances beyond their control. That is why incentive trusts must include some flexibility for the unexpected. You may want to authorize your trustee to provide hardship exceptions. If you are worried about favoritism, you could also include specific contingencies for common types of emergencies like:

  • Car accidents
  • Damage caused by weather events
  • Illnesses
  • Unemployment due to company layoffs

How to Choose the Right Trustee

A trustee in an incentive trust has the enormous responsibility to manage your family’s wealth and investigate whether beneficiaries are meeting your expectations. For your incentive trust to be effective, you will need to choose a trustee who is able to say “no” to a beneficiary who has gotten themselves into trouble. If the trustee is a family member, this can create bad blood and resentment among relatives. However, a professional trustee may not share your family’s priorities and moral direction. You should work with your estate planning attorney to select the right trustee to balance these sometimes conflicting demands.

Using Ethical Wills to Guide Your Trustee’s Decisions

Sometimes, the right balance means hiring a professional trustee and then providing additional guidance through an ethical will. Ethical wills are not formal estate planning documents. Instead, they are letters to your trustee that explain your values, and how they were formed. Often, they include:

  • Reflections
  • Mistakes made
  • Life lessons
  • Personal regrets
  • Spirituality
  • Philosophical beliefs

By reading these ethical wills, your trustee can better understand the motivations behind your incentive trust, and exercise their discretion in a way that better honors your wishes.

Get Help Crafting Your Incentive Trust

There is no form to create an incentive trust. Each one must be specifically crafted to suit the grantor’s wishes and goals. At Harrison Estate Law, we can help you lay out the conditions and rewards for your incentive trust, and help you consider whether other estate planning options are better suited to your needs. We will review all the details of your family and your estate and recommend the best strategies for your particular circumstances. Please contact us online or via email or call 352-559-9828 to schedule a free consultation. If you don’t live close to Gainesville we are happy to set up a phone or Zoom call.

Categories: Estate Planning