An incentive trust promotes your values to your heirs by setting stipulations before beneficiaries may receive funds. They are a popular way of discouraging frivolous spending and fostering a healthy work ethic. For example, they may provide a payment for a high GPA in college and on completion of a degree, or when the beneficiary takes on important responsibilities in the family business.
Incentive trusts may seem like a good idea to promote your values to your heirs, but sometimes they cause problems in the family. Beneficiaries may feel that you are trying to control their lives “from the grave” and may resent you for it. For this reason, it is important to discuss the stipulations in the trust and how they reflect your values.
You may have set unrealistic goals. Not everyone is meant to run the family business or achieve a 3.5 GPA through college. Beneficiaries who are unable to meet the requirements for funds disbursement may resent other beneficiaries who have met them. This can lead to arguments, family discord, and potentially a break in family communication.
Don’t forget each beneficiary’s other needs. Placing too much emphasis on academic achievements and business can have the effect of ignoring health and well-being. A good incentive trust will provide a safety net to provide for education, health care, and living expenses even if a beneficiary doesn’t meet the conditions for other disbursements.
It’s important to consider worst-case scenarios. What if the beneficiary develops a learning disability or is injured and has a disability? An incentive trust should provide for their care. What if the beneficiary has a drug-abuse problem, alcoholism, or gambling addiction? The trust should provide for treatment. One way to do this is to endow the trustee with flexibility when dispensing funds.
What if the heir becomes a stay-at-home parent or takes up a low-paid career, such as a teacher, social worker, or at a non-profit. You could elect to dispense funds based on the income of the spouse, tie funds to an amount adjusted for inflation, or fix funds relative to the average income for a lawyer or doctor.
A poorly planned incentive trust may have the effect of hindering the beneficiary’s ability to pursue their own professional interests as they are pushed into the family business or some other career in which they have little interest. A way around this is to double or triple match their income from other professions.
A best practice is to provide the trustee with a degree of flexibility to accommodate for unintended effects and changing circumstances. It is important to choose the trustee carefully and communicate with them your goals. The trustee must understand your intentions clearly in order to enforce the provisions effectively. The beneficiaries also need to understand your wishes so they trust the trustee. It’s impossible to see far enough into the future to anticipate all the curve balls life can bring. Making the incentives nonbinding can give the trustee the needed flexibility to adjust to unforeseen circumstances.