The key goal for many estate plans is to make sure our legacy to the family is positive, and that our descendants get the chance to make the most of what we leave behind. We all want what is best for our loved ones, and estate plans are crucial to making those hopes a reality.
But most estate plans leave very little room for control over how our financial legacy might impact our loved ones. We can give them the tools to succeed, but there is no way to guarantee that they might heed our instructions. Or is there?
Among the many ways wealth can be bequeathed, the incentive trust is one of the most specialized and restrictive. Unlike wills, incentive trusts allow a person to lock an inheritance behind a milestone or condition, providing an incentive for beneficiaries to achieve something or fulfill certain requirements to receive their inheritance. Let’s take a closer look at how and why an incentive trust might work.
Incentive trusts are living trusts that manage their contents for years after a grantor’s passing until the respective beneficiaries of the trust have fulfilled their qualifying obligations. These might be anything from starting a family of their own, to finishing college, finding employment, or founding a business.
Incentive trusts are one way of motivating your beneficiaries to pursue their dream or walk a better path. They can be used to pressure someone into getting help for their addiction, for example, or ensure that a beneficiary has reached the point of personal maturity needed to manage their inherited wealth properly.
Incentive trusts are usually funded with cash or an appreciating asset. Creating and funding a trust works very differently from setting up a will. Trusts are more like active bank accounts, wherein you appoint someone you trust to play the role of the bank.
Each and every trust has three important roles that must be fulfilled. These are the roles of the grantor (or creator), the trustee (or manager), and the beneficiary.
You do not necessarily need three different people to play each role – you can have several beneficiaries or several trustees, or create, manage, and be the recipient of a trust for multiple reasons – but for the sake of an incentive trust, you will likely have at least three separate parties involved.
The grantor or settlor is the creator of the trust. The trust is typically named after them, and it is with their own assets that they fund the trust. Most of the time, assets funded into a trust were first owned by the grantor.
The trustee is the manager of the trust following the grantor or settlor’s passing, or upon the grantor’s wish. Living trusts are created the moment they are notarized and funded, rather than upon the grantor’s death, meaning a trustee can be put in charge while the grantor is still alive. There can be multiple trustees, or successor trustees lined up to take on the responsibility of managing a trust if the first trustee is incapacitated or wishes not to continue their role.
The role of the trustee is usually the most complex, as they have a fiduciary duty to the grantor and the beneficiaries of the trust and must follow through on the purpose of the trust. It is also their job to inevitably dissolve the trust when the time comes, properly bequeathing its assets to the rightful heirs.
The beneficiaries of a trust can also vary. Some beneficiaries will only receive a trust’s income for the duration of its lifetime, while the remainder goes to someone else, or to an organization. Certain charitable trusts, for example, place an appreciating or paying asset into a trust to be managed for a beneficiary’s benefit, before transferring the assets to a charity.
For the purposes of an incentive trust, the beneficiary will only receive the trust’s contents after fulfilling the necessary requirements set by the grantor. Until these requirements are fulfilled, it is the trustee’s job to manage the trust and the assets therein.
The biggest strength of an incentive trust is that it grants you greater control over how and when your beneficiaries will receive their inheritance. With an incentive trust, your kids or beneficiaries aren’t simply going to unconditionally inherit their share of your wealth. Instead, you can set requirements that might help them grow as a person.
Incentive trusts are limited by your imagination, and the skill of your chosen estate planning professional. Some incentive trusts can be written to require a very specific condition – such as taking up the family business and managing it for at least five years, completing any form of secondary education, or even going into a specific career.
Other incentives can be vague. You can, or example, structure an incentive trust to pay out distributions on the condition that a beneficiary follows encouraged behavior, as per a statement of philosophy.
Incentive trusts are inherently restrictive. Forcing your child into any given path may lead them to resent you, or fight the trust. The trust document is legally binding, meaning that if you’re too particular with your language you may lock your child out of their inheritance – on the other hand, they might be able to find a loophole to get what they want prematurely.
A good incentive trust works around these issues by communicating them with the beneficiaries. Incentive trusts can be used to encourage behavior, but they can also be very alienating when they’re sprung on a beneficiary.
What if your beneficiary’s idea of happiness is something entirely different from what you might have envisioned? What if illness or unforeseen circumstances prevent them from fulfilling the conditions of your trust?
Incentive trusts are just one of many ways a trust can be structured to control how and when your wealth is distributed. If you worry about leaving behind an inheritance with little to no instruction, an estate planning professional can walk you through all your best options for distributing your wealth equitably and in accordance with your wishes.
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