For many, an important estate planning goal is to encourage their children or other heirs to lead responsible, productive lives. A popular tool for achieving this goal is the incentive trust, which conditions distributions on certain “acceptable” behaviors. But is this your best option?
Rigid distribution rules problematic
An incentive trust attempts to shape your beneficiaries’ behavior by conditioning distributions on specific benchmarks that are readily understandable and achievable. Examples include obtaining a college degree, maintaining gainful employment, or refraining from unacceptable behaviors such as drug or alcohol abuse or gambling.
In an effort to quantify acceptable behavior, some incentive trusts provide for matching distributions based on a beneficiary’s salary or charitable donations. Unfortunately, this approach can lead to unintended consequences.
For example, if your trust conditions distributions on gainful employment or matches a beneficiary’s salary dollar-for-dollar, it may discourage heirs from becoming stay-at-home parents, doing volunteer work or pursuing less lucrative but worthwhile careers, such as teaching or social work. If the benchmark is graduating from college or obtaining a graduate degree, the trust may unfairly penalize family members with disabilities or who simply lack the temperament or capacity for higher education.
One potential solution is to design a detailed trust document that attempts to cover every possible contingency or exception. Not only is this time-consuming and expensive, but, even with the most carefully drafted trust, there’s a risk that you’ll inadvertently disinherit a beneficiary who’s leading a life that you’d be proud of. Or, the trust may reward a beneficiary who meets the conditions set forth in the trust but otherwise leads a life that’s inconsistent with the principles and values you wish to promote.
Principles trump incentives
If you’re comfortable giving your trustee broader discretion, consider using a principle trust, instead. By providing the trustee with guiding values and principles rather than rigid rules, a principle trust may be a more effective way to accomplish your objectives.
A principle trust guides the trustee’s decisions by setting forth the principles and values you hope to instill in your beneficiaries. These principles and values may include virtually anything, from education and gainful employment to charitable endeavors and other “socially valuable” activities.
By providing the trustee with the discretion and flexibility to deal with each beneficiary and each situation on a case-by-case basis, it’s more likely that the trust will reward behaviors that are consistent with your principles and discourage those that are not.
Suppose, for example, that you value a healthy lifestyle free of drug and alcohol abuse. An incentive trust might withhold distributions (beyond the bare necessities) from a beneficiary with a drug or alcohol problem, but this may do very little to change the beneficiary’s behavior. The trustee of a principle trust, on the other hand, is free to distribute funds to pay for a rehabilitation program or medical care.
At the same time, the trustee of a principle trust has the flexibility to withhold funds from a beneficiary who appears to meet your requirements “on paper,” but otherwise engages in behavior that violates your principles. Another advantage of a principle trust is that it gives the trustee the ability to withhold distributions from beneficiaries who neither need nor want the money, allowing the funds to continue growing and benefit future generations.
Not for everyone
Not everyone is comfortable providing a trustee with the broad discretion a principle trust requires. If it’s important for you to prescribe the specific conditions under which trust distributions will be made or withheld, an incentive trust may be appropriate. But keep in mind that even the most carefully drafted incentive trust can sometimes lead to unintended results, and the slightest ambiguity can invite disputes.
On the other hand, if you’re comfortable conferring greater power on your trustee, a principle trust can be one way to ensure that your wishes are carried out regardless of how your beneficiaries’ circumstances change in the future.