Professionals collaborate in team meeting
Article | Concerned about the impact of an inheritance on your children?

What to know about incentives and trusts

The Gates children won't inherit their parents' billions. Apparently, each child will receive ten million dollars and the remainder of the estate goes to charity. Warren Buffett, Michael Bloomberg, George Lucas, Sting, Richard Branson and others are following a similar strategy.

Like many affluent parents, they have concerns about the impact a significant inheritance could have on their children. According to Buffett, it's wise to leave your children enough money so that they feel they can do anything, but not so much that they could do nothing.

If you're not ready to give the bulk of your estate to charity but you are concerned about the potential impact of inherited wealth on your children, there are other options. They include timing the cash distributions, adding general statements of intent to your estate plan, establishing incentive provisions in your trust — and even creating an incentive trust.

Most inheritances come with restrictions of one sort or another. In fact, it's not uncommon to include provisions in an estate plan that distribute an inheritance — often the principal or income from a trust — based on the age of the beneficiary. For example, distributing a third at age 30, another third at 35 and the remaining third at 40.

Of course, such an approach assumes that your beneficiary will be in a position to make better life decisions with more maturity. It also assumes he or she will be at least partially self-supporting before age 30.

Other than disbursing the funds in installments, or perhaps in addition to doing so, what can you do to create incentives for your children or other beneficiaries?

General statements of intent

Often estate plans and trust agreements include language describing the values of the benefactor or grantor.

For example, We want to ensure that our children and grandchildren receive a college education.

Or, We built our business from nothing through hard work, and we want our children and grandchildren to appreciate the importance of work in their lives. It is our intent that they shall not depend on the trust for support and maintenance if they are mentally and physically capable of earning a living.

Such language is typically referred to as a general statement of intent and can be quite elaborate.

Incentive provisions in a trust

You can take this a step further and actually build in incentives related to your goals, hopes, and values. They are generally referred to as incentive provisions. For example, one couple promised their grandson a new car if he successfully completed graduate school.

Other examples of achievements commonly linked to incentive provisions include earning a degree or other professional certification, creating or growing a business or professional practice, buying a home, getting married, raising a child, remaining employed, avoiding damaging addictions to drugs and alcohol, philanthropic endeavors and community involvement.

Incentive trusts

Finally, incentive provisions can be part of a free-standing incentive trust.

An incentive trust holds and manages cash or other assets for you, as the trust's grantor, to benefit your children or other beneficiaries. As with the incentive provisions in a more traditional trust you can distribute the assets in an incentive trust over time, perhaps based on the recipient's age, and you can link the distributions to a range of achievements. You can even include limitations on how the funds can be spent.

Advantages and disadvantages

Incentive provisions allow you to provide motivation and to encourage what you consider to be positive behaviors while discouraging objectionable ones — as long as the incentives and restrictions aren't against the law. But the incentives you create are not without potential downsides. As a result, they require careful consideration of possible unintended consequences.

They also benefit from open communication about your intentions with your beneficiaries and, depending upon the approach you choose, your trustee.

Sometimes referred to as controlling from the grave, incentive provisions shouldn't come as a total surprise to your beneficiaries and trustee — and typically should allow for some measure of flexibility or discretion in implementation.

Now for the potential downsides.

The incentives you create as part of an estate plan or incentive trust incur legal and administrative costs — both initially and, depending on your approach, over time.

Incentive provisions have the potential to generate unhappiness and even resentment on the part of your beneficiaries. For example, your children may envision a different future than the one you're incentivizing. Maybe you come from a long line of physicians but your daughter has a passion for architecture, not medicine. A provision that links a portion of her inheritance to completing medical school is not likely to be well received.

Other incentives may be based on unrealistic or unattainable expectations.

Because of the potential for unintended consequences when using incentive provisions, be sure to plan carefully and get great advice.

Marianna Willey

Related sections

California Pacific Coast Highway
Next up

California regional M&A update: H1 2021