ELITE ADVISOR BEST PRACTICES
Tips for handling the transfer of funds from one generation to the next
By Hyman G. Darling
- An incentive trust allows the grantor of the trust to reward heirs for their desired behavior.
- While it is easy to discuss the establishment of an incentive trust, there are complex legal, tax and investment issues that will also arise when creating this type of document.
- When setting up an incentive trust, the trustee must be aware of the grantor’s intentions and should possibly be given specific authority within the trust about how the funds should be distributed.
- No matter how well intentioned the design of the incentive trust is, make sure it does not violate any constitutional or public laws that would cause the trust to be in violation of a statute or regulation.
Sometimes people want to leave funds to their children, but they are concerned that their kids may not be responsible enough to manage them. Other parents or grandparents wish to ensure that inherited funds will not change the lives of the beneficiaries such that they will become “lazy” and not have the same work ethic as the older generation.
To address this concern, funds are often distributed at certain ages, such as one-third at age 30, one-third at age 35 and one-third at age 40. For other families, where the children are already somewhat older but perhaps the parent is not fond of the in-laws, the funds can be distributed at intervals such as 50 percent upon the death of the parent and 50 percent five years later but not exceeding a date later than when the child attains the age of 65.
As many advisors know, some parents and grandparents are concerned about education, morals and family values, business and vocational choices, and charitable and religious opportunities. In these types of situations, a person may want to establish what is known as an “incentive trust” that allows the grantor of the trust to reward heirs for their desired behavior. There may also be penalties imposed for undesirable activities.
These trusts may be used to provide extra support to the heirs who pursue advanced degrees or focus on family life, by providing income for the family so that both parents will not have to work and at least one may stay home raising the heirs’ children until those children attain a particular age. There also may be a trust to provide funds to the heirs who are committed to maintaining the family business, and additional financial support may be provided to those beneficiaries who work in a field that is not as lucrative as others, such as social service, teaching, etc.
Finally, some family members may wish to encourage certain behavior in their heirs by requiring specific observances such as religious or charitable opportunities. So if heirs are involved in a particular cause, such as missionary work, the trust fund will provide them with additional support for themselves and their families. And, they won’t have to worry about requesting additional funds from the trustee on a periodic basis.
When setting up an incentive trust, it is very important to be sure that the trustee is aware of the intentions of the grantor. Therefore, in addition to the usual provisions (such as having all income distributed with principal at the discretion of the trustee), the trustee should be given specific authority within the trust, and possibly even a letter of intent from the donor, as to when and how much funds are to be distributed. It is also important to be sure that one does not violate any constitutional or public policy law or standard that would cause the trust to be in violation of a statute or regulation.
In short, it is easy to discuss the establishment of an incentive trust, but there are significant and complex legal, tax, and investment issues that also will arise when creating this type of document. It is certainly not for everyone, and it should be used only in those situations where other types of trusts or investment vehicles are not appropriate.