Incentive Trusts offer the Settlor the ability to set conditions or clauses in a Trust Agreement for the protection of the wealth and to avoid abuse of any inheritances. We look at some examples with the children and spouses of when the Incentive Trust should be considered.
A Trust “Agreement” is a contractual obligation for the maintenance of health, support, and education of beneficiaries. The Agreement may have incentive clauses, the purpose of which is to encourage family members to achieve personal satisfaction in their lives and their dependents.
An Incentive Trust is an estate tax planning tool designed to encourage or discourage certain behaviors by the beneficiaries by using distributions of trust income and/or principal as an incentive or as the piece of cheese in a mouse trap to get the desired response. A typical Incentive Trust might encourage a Beneficiary to complete a college degree, enter a profession, or abstain from harmful conduct such as substance abuse. The Beneficiary might be paid a certain amount of money from the trust upon graduating from college, or the trust might pay a dollar of income from the trust for every dollar the Beneficiary earns.
Without being overly restrictive, trust documents can be written in such a way to cover beyond the basic needs of life, food, shelter, clothing, health, maintenance, education, and other guarantees to the well being of the beneficiaries. The trust document can include emergency clauses for the preservation of life of the beneficiaries to the full extent of trust funds. After all, what good is the money if beneficiaries are ill, disabled, or dead? Setting objectives and rewards for family members, not yet born is a way of anticipating an expectation of desired family values and assuring rules will be followed to produce the desired appreciation for the meaning of life.
Some incentive clauses and examples of Incentive Trusts:
Upon graduating a four year college of their choice (not basket weaving) the Trustee will write a check for the equivalent amount of the four year tuition plus 20% bonus for above average performance.
With proof of a W-2 or 1099 or other similar documentation, the Trustee will match the amount reported by 5 times the state earnings.
If a Beneficiary decides to go into business and the Trustee sees a reasonable chance of success, the Trustee will become the silent fund partner to the business plan.
Upon marriage, the Trustee will throw the wedding, the trust will buy the house, the trust may loan money to the spouse for business purposes, etc. at the sole discretion of the Trustee.
Other terms of the trust agreement may include staggered distributions over the ages of the beneficiaries, i.e. age 21 a distribution 5% of the Trust Corpus, 25, 30, 35, and so on in order to give anticipation of a new fresh start. We don’t know the maturity of the child, the acquired skill sets, the business acumen, spending habits, whether they marry, therefore Incentive trusts are a tactical way of saying that trust fund babies are not acceptable.
Other terms dictating distributions to wives, significant others, or other similar terms used to identify the Beneficiary’s relationship may be expressly excluded from ever becoming beneficiaries. This is to avoid potential threats to trust funds or unpleasant/ unwanted events.
The negative or con of an Incentive Trust:
This type of thinking within the trust agreements captures the imagination of the person who worked so hard to achieve success not to destroy those who he leaves behind without a lack of objectives, purpose, or meaning to their lives. The negative side of Incentive Trusts is that it becomes an inflexible instrument because the Settlor cannot foresee all potential problems, eventualities, and circumstances beyond the short duration of what was intended.
Incentive Trust example in action:
I was recently visited by a very successful business man who escaped Russia under extreme hardship, immigrated to the United States and became a very successful hard working entrepreneur. The business man expressed complete disgust in how his wife and children were performing. The wife was a blatant, out of control, spendthrift shop-aholic. The daughter, in her early twenty’s had taken-up with an ear, mouth, belly piercing jerk, adding tattoos to her body “embellishing the marks of slut.” Son number one just over the age of 21 was coming home all times of the night, receiving occasional calls from the police, putting his lawyer to work on keeping his son out of jail. Son number two was 180 degrees to the opposite, a star performer in a private school, quiet, reserved, but never came home or called, and kept to himself, I guess he was ashamed of his family.
Disappointed, the business man embraced the concept of an Incentive Trust, or better said, a revision to his existing Trust Agreement with incentive provisions, to take effect after his death. The key ingredient was the addition of the Trust Protector with powers to oversee the Trustee. He appointed his long time and good friend as the Trust Protector with specific powers to help his children lead more productive lives. Neither of his two older children had finished college, he had an incentive of a direct $350,000 distribution if either of them graduated. He made provisions for counselling and support payments for the duration of treatment and an improved lifestyle for his older son. To encourage his wife from aimless spending he would match and fund any business venture she actually participated. In addition, the Trust Protector took the immediate role of business wealth manager of Trust Assets and investment decisions. Additionally, he made provisions for direct distributions only to direct descendants to his children and grandchildren. If his wife remarried, none of the distributions would go for the maintenance of the new husband.
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