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Should you fund an incentive trust for your heirs?

Some estate-planning tasks require more finesse than others. Such is the case when considering whether to add an incentive trust to your estate plan.

Incentive trusts can be a strong motivational tool when they have been properly designed. However, they can be perceived as heavy-handed and an attempt to control the heirs from beyond the grave if the trusts are not carefully structured.

How incentive trusts differ from other trusts

The premise of incentive trusts is that in order to receive any proceeds, your heirs will need to achieve certain milestones and/or accomplish specific goals. Some incentive trusts link disbursements to age, e.g., receiving $25,000 at age 25 or $40,000 at age 40. Others are linked to accomplishments.

For instance, trust grantors may set up incentive trusts that pay out when an heir graduates from college or law school or gets an advanced degree. Others focus less on educational milestones and instead make disbursements when heirs marry and bear children.

Why you might need one

Not all heirs need the motivation of an incentive trust to encourage them to make the most of life's opportunities. However, if you have a child or grandchild who appears to be a slacker just coasting through life, an incentive trust can be a powerful motivational force to help your heirs reach their full potentials.

These trusts can also be closely tailored to address the specific needs of your heirs. Perhaps you have an heir who can't seem to keep a job or has a lifelong struggle maintaining sobriety. You can set up the incentive trust to only disburse funds when the heir is gainfully employed and/or sober.

Negative consequences of incentive trusts

In some instances, incentive trusts can backfire. Perhaps you have fund disbursements linked to the birth of the heir's first child and all subsequent children. Later, your heir may learn that he or she (or the heir's partner or spouse) can't conceive or bear children, which would present legal roadblocks to your heir receiving any funds from the trust.

Problems could also crop up with a trust that pays out only if an heir is employed. If the heir became disabled and can no longer work, the terms of the trust would bar future disbursements without a legal challenge.

Some incentives may not stand up in court

There are limits to what you can expect an heir to do — or not do — in order to receive trust assets. Courts would likely strike down any incentives that require an heir to practice a specific religion, only marry a partner of a certain race or divorce a spouse that the grantor perceives as unsuitable. To that end, incentive trusts should not be punitive in nature.

The role of trustee

As it will be up to the discretion of the trustee to ensure that the incentive conditions of the trust have been met when making disbursements, you should only appoint a trustee whom you feel will uphold your intents and wishes.

An ideal trustee will have common sense and the ability to be fair in his or her decision-making capacity. You'll also want to make sure that your appointee is trustworthy and capable of making good business decisions regarding management of the trust assets.

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