Incentive Trusts: Setting Guidelines for Your Heirs

Posted by Richard on February 14, 2013


An incentive trust is an estate planning tool that allows the trust grantor to reward heirs for desired behavior. It also allows the grantor to impose appropriate penalties for undesirable activities.


Some common themes contained in incentive trusts:


• Education: Incentive trusts have been used to provide extra support to those heirs who pursue advanced degrees, focus on designated fields of study, or attend specified institutions. Some trusts are designed to reward instances of outstanding scholarship and academic achievement. Some permit withholding support from those who fail to meet minimum levels of accomplishment.

Moral and family values: Some trusts are intended to promote family life by providing income support payments to heirs who choose to stay at home with children. Some trusts offer beneficiaries bonuses for childbearing, foster care, or adoption. Some withhold benefits from those heirs who might be convicted of a crime or fail a prescribed drug or alcohol screening test.

• Business and vocational choices: Entrepreneurs can use trusts to provide incentives to those heirs who commit to helping carry on a family business. Trusts can be designed to encourage or discourage career choices specified by the trust creator. Trusts can also be used to offer focused financial support to those beneficiaries who opt to follow paths that are personally and socially rewarding yet generally less lucrative.

Charitable and religious opportunities: Some trusts are designed to encourage religious behavior by requiring specific observances. Some trusts provide funds for dues or other costs associated with religious participation. Some subsidize those heirs who choose missionary work or other religious vocations. Some provide matching funds for heirs’ contributions to favored organizations.


Incentive trusts can provide many of the same benefits as other trust structures. For example, by placing assets in a properly designed trust, you can move them out of your estate in order to manage tax liabilities more efficiently. You can also ensure that assets will be managed professionally and held in safe custody through a stable financial institution.


Key Limitations


Just as you have broad discretion as a parent or guardian, you have great latitude when you create an incentive trust. But there are limits. The trust cannot, of course, require blatantly illegal activity; neither can it provide incentives for actions that might be deemed contrary to public policy — violating the unwritten laws of the community. For example, a trust generally cannot provide incentives for a beneficiary to divorce an unpopular mate, nor can it be used to undercut existing voluntary separation, child support, or other domestic arrangements generally permitted by law in your state.


Incentive trusts may be subject to what is called the rule of perpetuities, a legal concept that says trusts must be liquidated at some definite interval after their creation. This rule is enforced in many, but not all, states. It applies to trusts that are created in the state where the rule is enforced (you may generally create a trust in any state, not just the state in which you reside). As a consequence, you’ll want to be sure that any trust you do create can last for as long as needed to achieve your goals.


Certain types of incentive trusts may also be subject to the generation skipping transfer (GST) tax. Where an incentive trust fits the complex definition of a GST, the rules limit the aggregate amounts that can be placed in the trust without incurring a tax of about half of the value in the trust. In some trust scenarios, life insurance can augment the amounts permitted under GST rules.


Creating an effective incentive trust involves complex legal, tax, and investment management choices. This article offers only an outline; it is not a definitive guide to all possible consequences and implications of any specific trust option. For this reason, be sure to seek advice from knowledgeable legal and financial professionals.


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