Dear Savvy Senior,
What can you tell me about incentive trusts? I have two adult children that are financial disasters. Before I die, I want to put some type of requirements in place that they will need to follow in order to receive their portion of my estate. Otherwise, they’ll blow it all in the first year.
If you want to influence your family members even after you’re gone, an incentive trust is definitely an option to consider. Here’s how it works, along with some tips to help you create one.
An incentive trust is an estate-planning tool designed to help prod your heirs in a direction you desire when you’re no longer around.
With an incentive trust, some or all of your assets are passed to your trust when you die rather than directly to your heirs. Your trustee is empowered to distribute funds from the trust only if and when your beneficiaries do whatever it is you have specified in the trust.
For example, an incentive trust might encourage a beneficiary to graduate from college, enter a particular profession, get married or even have children. They could also reward beneficiaries who do charitable work, or supplement the incomes of those who choose low-paying, yet meaningful careers like teaching or social work. Or, they could penalize beneficiaries who don’t work by cutting off or decreasing distributions, or placing restrictions on heirs with addictions by requiring that payments go directly to rehab centers.
But be aware that these types of trusts can also have drawbacks. A poorly constructed incentive trust can have a high risk of unintended consequences. For example, if your trust provides a financial incentive for your children to be employed full-time, but one of them gets sick or seriously injured in a car accident and can’t work, they would be punished unfairly.
You also need to know that incentive trusts aren’t cheap. You can expect to pay an attorney $2,500 to $5,000 to draft one.
There are also legal limits on what you can do with an incentive trust. While state laws vary, incentive trusts that encourage a beneficiary to join or leave a particular religion, or leave a spouse or not marry at all, can be challenged in court and possibly struck down.
How To Make One
To create a solid incentive trust that accomplishes what you envision, tell your estate-planning attorney that you want to include precise instructions that clearly spells out your wishes, but you also want to include language granting your trustee the right to use his or her discretion and that the trustee’s decisions should be final and binding.
This allows your trustee to make common sense rulings, which will reduce or eliminate the chances of unintended and unfair consequences. It also makes it very difficult for beneficiaries to successfully challenge the trust or trustee in court. When a trust grants final decision-making authority to its trustee, it becomes almost impossible for beneficiaries to successfully argue that this trustee is not correctly implementing the trust’s terms.
The key is to select a trustee who’s smart enough to interpret your intent and has sufficient backbone to stand up to beneficiaries when necessary. You also need to select a successor trustee too if your first choice can no longer serve. Fees paid to a trustee vary widely depending on the state’s fee schedules, the size and complexity of the trust, and conditions laid out in the trust.
Send your senior questions to: Savvy Senior, P.O. Box 5443, Norman, OK 73070, or go to SavvySenior.org. Jim Miller is a contributor to the NBC Today show and author of “The Savvy Senior” book.