Incentive trusts are a popular way for people to encourage good behavior from their heirs. However, incentive trusts have limitations and you should be aware of them.
Everyone would like to see his or her heirs do well for themselves. A real fear exists that if an heir is given a great sum of money, the heir will do little with his or her own life and just live off the money.
Instead, people want to see their heirs go to good schools, get into professions and have families.
One popular response to this is to create incentive trusts. In these trusts beneficiaries receive distributions when they behave in a certain way or accomplish something, such as getting a college degree or getting a job.
While these trusts do often work well, as Investopedia points out in "Incentive Trust Pitfalls Advisors Should Know," there are two potential ways these trusts can become unworkable:
• The Trusts Are Too Inflexible – Sometimes things in the trust that seem like a good incentive generally do not work well for individual beneficiaries. For example, a trust might distribute money to a beneficiary upon receiving a college degree, but what if the beneficiary enters a profession that does not require a degree, such as the military, being a professional athlete, or being the next Bill Gates and founding a successful tech startup. If the trust language is too rigid, the trustee will not be able to distribute assets to these beneficiaries even if the person who created the trust would have wanted to.
• The Trusts Are Too Vague – On the other end of the spectrum some incentive trusts are too vague. For example a trust that distributes money to a beneficiary when the beneficiary enters a respectable profession or gets a good job might require the trustee to make difficult judgment calls about a good job or respectable profession.
If you are considering setting up an incentive trust, it is important that you work closely with an estate planning attorney to create the trust in a way that is neither too inflexible nor too vague.
Reference: Investopedia (Dec. 11, 2015) "Incentive Trust Pitfalls Advisors Should Know"