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Trusts
Incentive Trusts Gain Momentum
By Russell Lowry
Wealth Planning Advisor, Sagemark Consulting / Lincoln Financial Advisors
It’s long been a given that growing up amid enormous wealth can have a corrosive effect on children, and many parents want to do all they can to avoid those pitfalls.
“The parents I talk to are very concerned about not spoiling their children,” says Mel Bannon, a Westlake Village, Calif.-based financial planner with Sagemark Consulting (a division of Lincoln Financial Advisors Corporation), who counsels wealthy families on estate planning issues. “They want to make sure their children never become poor, rather than seeing to it that they become rich.”
Accordingly, many parents often turn to what’s known as an incentive trust to guide how an inheritance can be used. “As we age, we’re thinking in terms of how best to empower our children to do the right things when we’re no longer here to direct them,” says Bannon. “In that regard, the incentive trust will always be a very important part of estate planning.”
Passing on Values
Indeed, such trusts, while a fixture of estate planning for decades, are gaining in popularity as the baby boomer generation nears retirement age. Those who were born between 1946 and 1964 have been the beneficiaries of the largest intergenerational wealth transfer in the nation’s history. They’re also a very socially conscious generation. Now that their children are reaching adulthood, many boomers are using incentive trusts to encourage their kids to become responsible citizens.
Under the Internal Revenue Code, incentive trusts are permissible to maintain the health, education, maintenance and support of an offspring. They can include almost any instruction. “The single most common incentive is to provide access to or a distribution [from the trust] upon completion of a college degree. This seems to be a common theme,” says Bannon.
Another common practice is to tie distributions from a trust to a child’s own income. “If earnings from a job are $50,000 a year, they get a percentage or matching value; that’s another trigger,” says Bannon. “We also get into situations where there are drug or alcohol issues with one of the children. If they give evidence or proof that they are staying substance-free for a certain period of time, then they have access to the trust.”
Plenty of Flexibility
There are very few limits on the stipulations that can be incorporated into a trust, and although rare, some instructions can be somewhat eccentric. “A few years ago I had a case with a woman who had no children or heirs. Her entire estate went to the Humane Society on the condition that they kept her dogs in her home and cared for them until they died,” Bannon says.
Some parents have reservations about the undue influence their child’s spouse might have, and add provisions in a trust to keep money from going to that spouse. Other provisions may limit withdrawals to a certain percentage of trust assets or base distributions on the age of the heir. Some trusts are even set up to skip generations.
In extreme cases, parents will appoint an independent trustee to oversee the trust, and force their children to petition for distributions. “It’s pretty much a blank sheet of paper. This is the client’s money. They have a right to decide who gets it, when and how. Short of fraudulent behavior, the client can write what they want,” says Bannon.
Some experts warn that incentive trusts may spark resentment among children because the kids may feel that their parents are trying to control them from the grave. But those situations are rare, says Bannon. In most cases, the children are appointed as trustees. The situation, however, can get sticky if there are two or more children and one is put in control over the others’ trusts. “You have to ask what effect that’s going to have on the children’s relationships,” he says.
Incentive trusts provide all of the asset and tax protections of any other trust instrument and can be set up to be revocable, so there’s plenty of flexibility. “Parents can change the deal until the day they die,” he says. However, Bannon notes that he’s never known of a case where a child has legally challenged a trust’s stipulations and won.
Talk to Your Financial Planner About:
The values you wish to pass on to your children.
Estate planning design strategies.
Funding your trusts.
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