Leveraging Trust Provisions to Incentivize Beneficiary Behavior

Adam J. Centner

For many individuals new to estate planning, particularly younger couples, there is something almost taboo when you start to discuss a revocable trust: does that mean our children will be trust fund babies? 

Of course not! Trusts often play an important role in an estate plan, and for good reason: from probate avoidance to creditor protection to outside financial management, trusts are an important mechanism for the responsible transfer of wealth from one generation to the next. And for many individuals, trusts are simply a conduit to hold and manage assets until their children reach an appropriate age to take over management of those assets themselves.

But for some, trusts can offer a detailed structure to guide children through life’s obstacles or temptations when the parents are no longer around. This type of planning – sometimes referred to as incentive trust planning – is becoming increasingly common and often results in creative problem solving intended to leave an impact for decades. Incentive trusts generally contain specific provisions that are designed to incentivize (or disincentivize) certain actions for those inheriting new or unearned wealth beyond simply providing an ascertainable standard or requiring an independent trustee.

Some of the more common incentive trust provisions include:

1. Employment. For the potentially underperforming beneficiary, a trust can be structured to permit the beneficiary to access funds only if the beneficiary is gainfully employed. A trust may also be drafted to match a beneficiary’s salary or retirement contributions to incentivize employment. The intent may be to encourage the beneficiary not to squander a talent or to prevent a lifetime of couch-surfing – as Andrew Carnegie famously said: “The parent who leaves his son enormous wealth generally deadens the talents and energies of the son” – but it’s also important to remind your client not to try to control too much from the grave. The trust should consider other worthy endeavors, such as being a stay-at-home parent or an avid volunteer or thriving in a low-paying career, and the employment provisions should be broad enough to allow the beneficiary to pursue his or her own path in life and not feel pressured down a certain road only for the sake of maintaining access to trust funds (e.g., in one case, I discouraged a client from including a provision that allowed access to trust assets only if the son was still running the family business). A trust may also incentivize related endeavors, such as starting a business, or defer substantial distributions until the beneficiary is past his or her teens and 20s where immediately available resources may serve only to drain the beneficiary’s motivation before launching into a career.
2. Substance Abuse. One of the most common (dis)incentive provisions is the “locking down” of trust assets if a beneficiary is suffering from substance or alcohol abuse, and some trusts also include a provision requiring the beneficiary to submit to drug or alcohol testing upon request of the trustee. Although this provision is certainly sensible on its face, the grantor (the trust creator) should also consider permitting trust funds to be used for rehabilitation centers or other services that would enable the beneficiary to address and overcome the issue as well as designating an unrelated individual or corporate fiduciary to manage the trust assets in a helpful but stern manner.
3. Life Milestones. To honor and reward a beneficiary for achieving certain milestones, a grantor may wish to provide lump sum distributions at certain points in the beneficiary’s life, such as graduating high school or college, obtaining that first full-time job, marrying, joining the military, or even retiring after years of service. It’s also possible to draft more specific incentives, such as the availability of additional funds after attaining a certain grade point average or attending graduate school. While some specific provisions – such as a “bonus” distribution if the beneficiary attends the grantor’s alma mater – may seem harmless, grantors should also keep in mind that those types of incentives may cause resentment from the beneficiaries if they feel the grantor is forcing them into decisions they otherwise would not want to make.
4. Encouraging Dreams. Some of the more positive incentive plans that I have drafted are to reward beneficiaries for pursuing their dreams. One client, for example, has a daughter who has always dreamed of running a cat shelter, but he knows she will never pursue it on her own. To help, we drafted his trust to provide that an amount otherwise allocated to charity will instead go to her, if she desires, for the purpose of opening a cat shelter, and if she decides not to use it, the funds will be donated to charitable causes of her choosing. There is no guarantee she will take the trust up on the offer – after all, we have no idea the circumstances of her life when that time comes – but she may just decide to do it, and if she does not, there is still on effect on her overall trust assets. And if nothing else, the clients hopes she will appreciate the loving gesture from her dad.
5. Encouraging Relationships. Another positive incentive plan encourages family members, particularly the grantors’ children, to spend time together. For families that own a lake house or second home, this is particularly common. It is not unusual for children to have different attitudes toward the fate of a lake house at the parents’ death. Some children may love it and want to maintain the nostalgic getaway for generations, while others may prefer to cash out or spend time elsewhere. It is important not to be too rigid in the planning, but I regularly draft provisions where a nominal amount, say $100,000, is set aside at the parents’ passing for 3-5 years of lake house expenses. The trustee is directed to retain the lake house during that period of time and to use the set-aside expenses to care for it. This allows the family to adjust to a new normal without the parents’ active management of the property and buys some time for its collective use. At the end of that period, the children can decide how to proceed, perhaps all going in together to retain the property or one sibling buying out the interest of another, or simply selling it entirely. For longer-term properties, particularly where all children are on board with retaining it, a more owner-friendly structure, such as an LLC, may be warranted. A second common relationship incentive is to set aside funds for children to travel to visit or vacation with each other. For many parents, there is no better legacy than their children and grandchildren spending time together.
6. Future Planning. Finally, many wealthy clients are not only concerned about their own estate plans, but their children’s estate plans as well. Some clients choose to prohibit outright distributions to descendants without a prenuptial agreement or the child’s own estate plan in place. This type of provision should always be careful not to prohibit the beneficiary’s use or access to the trust funds entirely but to incentivize downstream planning by limiting distributions that would be made outright to a descendant without a particular purpose if that planning is not in place.

Very few clients come to us, as their advisors, with these specific strategies in mind. But it is our job to listen to their goals, hopes, and concerns, and to think outside the box to find ways to help them reasonably incentivize their beneficiaries to live their best lives.

If you wish to further discuss incentive trust planning, or if I can be of any help to you or your clients on any estate planning matters, please call or email me.

Adam J. Centner
Partner
513.579.6488
acentner@kmklaw.com.