The INCENTIVE in incentive trusts Featured

9:45am EDT July 22, 2002

The economy has been good to you, perhaps so good that you’re thinking of creating a trust fund to preserve your wealth for your heirs.

But many entrepreneurs who have boot-strapped their way to the top chafe at the idea of giving their heirs the proverbial silver spoon. That’s where incentive trusts come in.

Incentive trusts allow you to create certain incentives that must be upheld to receive payment. Incentive trusts can influence a beneficiary to act in a certain positive way or to refrain from a specific negative behavior.

They include incentives to encourage a child to pursue an education, to work hard or to render community service. Or, an incentive trust could be created to discourage excessive consumption, laziness or self-destructive behavior.

But there is more to creating incentive trusts than meets the eye.

Oh, so popular

Americans have greater wealth now than possibly at any other time in history. While a few lucky people have inherited their wealth, the majority have earned it through hard work and long hours. The psychological impact of inheriting wealth vs. earning it is worlds apart.

For many who have earned their wealth, the attitude of, “I did it the hard way and so should you,” often prevails. Even those who don’t insist that their children share their work ethic have concerns about how their wealth will impact their children and grandchildren.

Incentive trusts let you set the rules. If your goal is to promote education and hard work, you could direct your trustee to distribute funds to your child only after he or she successfully completes each year of college and, after graduation, as he or she achieves certain career benchmarks. You could, for example, elect to reward your child with one dollar for each dollar that he or she earns on an annual basis.

The disincentives

Incentive trusts are, by their very nature, mechanisms of control. Not every child has the desire to go to college or perhaps the intellectual ability to successfully complete college. Perhaps you have a child who is extremely bright and would prefer to start a business.

What if one child is a highly paid physician while another is a lower-paid public school teacher? This is where the incentive trust gets complicated.

It probably would not be your intention to reward one child to a greater degree than the other on an earn-a-dollar, receive-a-dollar basis when both are contributing to society.

What if one of child develops health problems, which interfere with his or her ability to work? Your incentive trust could inadvertently penalize a child as a result of that.

Discretion, objectivity and structure

How would these contingencies be handled? In a word: discretion. As grantor, it’s important to give your trustee as broad a discretionary flexibility as possible in determining the amount to be distributed to a particular child.

Often it’s best to have a nonfamily member to serve with a family member trustee to make these determinations objectively. You also will wish to protect your trustee as much as possible from potential lawsuits that could be brought by an unhappy beneficiary.

Before you establish an incentive trust, consider other legal structures, such as a family limited partnership or a limited liability company, to achieve your objectives. Identify your goals and consider how the transfer of your wealth to your children and/or grandchildren may affect them and their plans for the future.

Mary Frances Dean heads estate administration at the law firm of Houston Harbaugh. Reach her at (412) 288-1846.