Passing On More Than Just Wealth: The Pros and Cons of Incentive Trusts

As parents and grandparents, we inherently hope that our children and grandchildren will act responsibly when handling an inheritance, regardless of its size. However, the pressure and responsibility that comes with inheriting wealth from loved ones are things that some children and young adults can be unprepared for, and many end up spending a large portion of the money in a short period of time with no outlook on the future. To avoid this, we can reinforce values and encourage success for our heirs through what is known as an incentive trust. With this type of trust, your heirs can be monetarily rewarded for making good life choices and you can rest assured that their lives are going in the right direction.

Pros and Cons of Incentive Trusts

What Is An Incentive Trust?

An incentive trust is a legal entity that, like other trusts, holds and manages the grantor’s assets for the eventual distribution to the beneficiary. The incentive trust can be used as a motivational tool for the beneficiary to reward them for accomplishing certain behaviors or goals set by family members. Additionally, with an incentive trust, specific requirements can also be put into place to determine how the inheritance will be distributed.

What Are Some Benefits of the Incentive Trust?

Though similar to other trusts, the incentive trust is a lesser-known estate planning tool used by families to guide their heirs in the right direction post-mortem. In this article, we’ll dive into some of the benefits and drawbacks of having an incentive trust in your estate plan. First and foremost, one advantage is that the incentive trust can be used to encourage positive behavior. As previously mentioned, this trust allows you to reward your heirs when they achieve a certain goal. For undesirable behaviors, including unproductive or detrimental activities and behaviors, access to the inheritance can also be limited by the grantor. As long as all restrictions remain legal, the trust can be as restrictive as the grantor desires. Another benefit and common use of the incentive trust is the ability to place age restrictions for asset distributions. For example, a grantor may want their child or grandchild to receive their inheritance when they reach a more mature age rather than receiving the entire sum as soon as they turn 18. A grantor can also plan for funds to be distributed over a period of time. This way, the beneficiary can handle the inheritance more responsibly as it will be given in smaller amounts over time rather than a lump sum all at once, further reducing the possibility that the beneficiary will squander the entire inheritance.

Encouraging education is another advantage of incentive trusts in which the trust is similarly used as a motivational tool. For example, if your child is enrolled in high school or college and you decide to set rewards for achieving specific grade point averages, receiving a portion of the funds at the end of a great semester can motivate that child to continue working hard and further their education. Another example would be obtaining the funds when the child has graduated from a certain educational institution. Similar to being used to encourage education, incentive trusts can also help promote a healthier lifestyle. A grantor can establish a trust that will not distribute money if the beneficiary is found taking part in destructive or illegal behavior. Such behaviors include alcohol and drug abuse, gambling, crime, or anything else the grantor believes constitutes destructive behavior.

You can also include conditions in your trust that reward your beneficiary for moving up the ladder in their career by means of promotion, new skill-learning, or other notable achievements. If you own a family business and your beneficiary decides to undertake significant responsibilities, you can establish a reward for completing certain tasks. For example, a portion of the inheritance funds can be rewarded for a certain amount that the beneficiary earns at work, and henceforth. This factor may appeal to parents with children whom they would like to have learn responsibility and the importance of earning money through diligence rather than a handout.

 Another benefit of the incentive trust is the ability to endorse and encourage philanthropy. For example, the beneficiary can be rewarded for taking part in charitable habits such as volunteering or making donations to charities.

What Are the Drawbacks? Should I Have An Incentive Trust in My Estate Plan?

Having discussed the numerous benefits on the incentive trusts, it’s important to understand that this type of trust is not for everyone, and can come with unanticipated drawbacks. For example, even though a grantor may have the best intentions in encouraging education and gainful employment, the conditions put in place in an incentive trust may feel insurmountable to the beneficiary and further, may cause the beneficiary to feel discouraged. This may create a feeling of resentment towards the grantor for setting such unachievable goals for the beneficiary. For example, a parent wanting their child to become a doctor can incite negative sentiment from their child if their intended field of work is entirely different. If the goal isn’t in line with the child’s abilities or aspirations, it will seem unrealistic and will likely never be attained. That being the case, it is important for grantors to consider their children’s occupational interests and set more realistic and productive goals, rather than creating resentment through unreasonable expectations.

Another downfall to consider is that incentive trusts can hinder entrepreneurship. As mentioned, it is possible that the direction the beneficiary is being pushed in is not the direction of their choice. Further, the child may feel frustrated as a result of not being able to pursue their own interests and build their own career.

Oftentimes, other needs are overlooked as well. Grantors may not acknowledge the fact that business and academic goals can be extremely stressful to attain and can affect the overall health of beneficiaries. For example, if the beneficiary is losing sleep and not maintaining their health, this can hinder them from producing desired outcomes.

It is important to understand that while incentive trusts may be the perfect addition to some estates, they may not be suitable for many others. The benefits and drawbacks of incentive trusts discussed earlier should be thoroughly weighed to make the best decision possible regarding the type of trust created as well as any restrictions added if considering an incentive trust. The intentions of the trust should be to encourage and reward, rather than to control or to punish; there should be an understanding of all expectations and wishes before the grantor’s death and the intentions should be clear. The goal of the incentive trust is to pass on wealth in exchange for good morals, values, and life lessons to guide your heirs. If you or a loved one are considering adding an incentive trust to your estate, it is imperative that you consult with an estate planning attorney who can guide you through the process of figuring out if the trust is right for you and setting one up so you can rest assured that your children are on the right path after your death.