Incentive Trusts: Making Heirs Work for the Money
According to this study sponsored by Allianz Life Insurance, non-financial items that parents leave behind--like ethics, morals, faith, and religion--are 10 times more important to both boomers and their parents than the financial aspects of inheritance. Little wonder then that estate planners have responded to this "values driven" estate planning perspective with trust vehicles that provide positive financial incentives for behavior parents and grandparents want to encourage, as well as financial disincentives for behavior parents and grandparents want to discourage. These trusts are referred to as "incentive trusts," and they are gaining in popularity.
The New York Times recently reported here on the growing acceptance and use of incentive trusts as estate planning tools. Although the article was well written, what I find most interesting is the fact that it was written at all. What was once as little-known planning device has now apparently gained such widespread acceptance that it warrants national attention in a general circulation newspaper.
Below are a few excerpts from the linked-to New York Times story:
"In traditional trusts, beneficiaries receive money at a certain age, but in incentive trusts, heirs must reach milestones or take actions. For example, children might receive a $25,000 bonus when they graduate from college or marry. Or they might receive funds matching money they earn."
"Mr. Holzapfel, who has many wealthy clients in the technology and real estate fields, says he has seen a growing interest in performance-based trusts."Quite a few people worked their tails off in high tech, working 24/7 for years, and made a lot of money," he said. "They have a very strong work ethic, and they want their kids to as well." Among his clients with young children and assets of $10 million or more, about 60 percent have incentive trusts.
Critics, however, call incentive trusts too inflexible and say that some parents can be too controlling. A trust that offers a dollar for every dollar earned can be unfair, the critics say, because it gives big rewards to already-successful business people and much smaller amounts to heirs who may work just as hard but have chosen careers as, say, artists or teachers. (And unless other provisions are made in the trust, homemakers and volunteers may get nothing.) Critics also say that some incentives may go so far as to pay children to provide their parents with grandchildren."
"The Bessemer Trust Company, a wealth management firm, serves as trustee for about half its 1,800 client families, who have a variety of estate plans. William H. Forsyth Jr., the firm's chief fiduciary counsel, says the biggest fans of performance-based wills are typically "C.E.O. types who tend to be quite controlling" and those with first-generation wealth because "they are the most scared by it." Because incentive trusts are relatively new, he predicts many legal challenges from heirs." (Emphasis added.)
Hi, Juan-
I was thinking about this, and having a hard time coming up with reasons why these legal challenges would be successful. I mean, I don't doubt that the challenges will be made, but what's the rationale for a ruling in favor of a beneficiary? Maybe language that's against public policy (like "if you divorce your wife, whom I've always hated, you get $10 million"), but such cases are fairly rare, I think. I've always thought that most courts have a clear bias (for lack of a better word) in favor of the testator/grantor -- will that change for cases that seem to create a hardship (like the case of the homemaker or volunteer)?
Joel,
I don't think incentive trusts are anymore inherently vulnerable to legal challenge than any other type of trust, but I do think incentive trusts lend themselves to a greater degree of "creative license" than is otherwise the norm. When families (and their attorneys) start loading trusts with dispositive provisions that are untested or in some way inappropriate (or maybe just silly), that is where I would expect the trouble to come from. In other words, trust "design" will probably be the culprit if incentive trusts do end up being contested in large numbers. Here are a few examples of the type of litigation-magnet trust provisions that I expect are probably more likely to pop up in incentive trusts:
1. Trust provisions automatically disinheriting someone if they do/don't engage in the type of behavior the trust grantor wants to encourage/discourage. In this context, the disinherited beneficiary has nothing to lose and everything to gain by contesting the validity of the trust provision in question or the trustee's actions.
2. Trust provisions that violate public policy. Classic examples include disinheritance if the trust beneficiary marries someone who isn't of a certain religion, race or ethnicity.
3. Trust provisions that create administrative nightmares. For example, trust provisions that require a trustee to obtain information that is virtually impossible to verify (e.g., did the beneficiary try real hard to find X type of job this year), trust provisions that are susceptible to multiple interpretations with respect to whether the beneficiary "passed or failed" a particular test triggering greater/lesser fund distributions, and trust provisions that are susceptible to manipulation by trust beneficiaries.
One could always draft the incentives as matters for the Trustee to take under advisement, but keep the standard the usual, "health, education, support, and maintenance" in the sole discretion of the trustee. Combine that with a Trust protector to make sure the values of the Trustor are followed, and you've pretty well insulated the instrument from attack, plus you've got a blaring neon sign advising the kids/grandkids what to do...
Russell - I agree with you. Also, couching the trust incentives in precatory language (as you suggest) coupled with provisions providing for trustee discretion to withhold distributions if it would be in the beneficiaries best interest, would deliver asset-protection values not available under a mandatory-distribution regime.