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Dec 2017
12
December 12, 2017

Motivating Your Heirs: Incentive Trusts and Ethical Wills

Many clients express concern that an inheritance may have a negative impact on their children. This is often the case for clients who created their own wealth, experienced hard work and spent and/or invested their earnings carefully. Will leaving an inheritance to their children inhibit their children’s drive and make their children complacent? Will an inheritance make life “too easy,” depriving their children of the benefits of “making it” on their own? Frequently our conversation turns to incentive trusts, and whether an incentive trust might counterbalance the perceived negative effects of “free money.” 

Incentive trusts are trusts that permit payments to a beneficiary contingent on certain goals being met, or certain behavior being avoided. At first blush, incentive trusts seem like a great idea. Shouldn’t they simultaneously motivate a beneficiary while conveying what is important to you and the life lessons you have learned? As with all things in life, it is not this simple and there are pitfalls with incentive trusts. What if the beneficiary is physically or mentally unable to achieve the stated goals? What if a beneficiary wants to stay at home to raise a family, or pursue a career in a meaningful field that pays a low income? 

Further, an incentive trust is invariably a subjective analysis. Providing measurable targets to the trustee and the beneficiary is critical to achieving your goals and making the trust workable. Will the person you’ve selected as trustee be willing and capable of evaluating the beneficiary and denying a payment if the beneficiary does not meet the goals? 

Incentive trusts are necessarily more expensive to craft because they must be specifically tailored to you and your heirs and to the behavior you want to motivate or discourage. If you are convinced that an incentive trust is right for you, however, there are some things you can do to increase the likelihood of success and minimize bad feelings:
 
  • Create a specific list of behaviors you want to motivate or discourage, the specific criteria the beneficiary and trustee will use to measure progress and whether there will be time limits to achieving goals (e.g., the perpetual student problem). Examples include directing a payment to a beneficiary upon graduation from college, for achieving certain grades or to match a beneficiary’s W-2 income. Or payments may be prohibited if the beneficiary engages in self-destructive behavior, such as substance abuse. Think through as many possibilities as you can to plan for the unexpected, and provide specific examples.
  • Describe why these terms are included. Is it so that the beneficiaries will be engaged, contributing members of society? What does that mean to you?
  • Identify the reward for meeting the objectives. It could be a percentage of trust funds or a stated dollar amount, or merely that the trustee, at his/her discretion is permitted to make a distribution of any amount.
  • Carefully select the trustee who will make these determinations. Will the trustee be capable of saying “no” if objectives are not met? If the trustee is a family member, how will saying no affect the trustee’s relationship with the beneficiary?
  • Consider giving the trustee flexibility to make payments in certain circumstances even if a beneficiary cannot meet the criteria. For instance, if circumstances substantially change or a beneficiary is incapable of achieving the stated goals due to no fault of his or her own.

Good communication between you, the trustee and the beneficiary is key to the success of the trust. Consider writing side letters explaining in your own words why you included these terms, what you hope is achieved (or avoided), and your philosophies about life lessons that matter to you.

These side letters are often referred to as ethical wills. They can be the documents by which you transfer your values and reflections on life, and should include mistakes from which you’ve learned as well as successes from which you’ve gained. A few topics to include in your side will could be:
 
  • What made you happiest in your life? 
  • What are you most proud of?
  • What are your biggest regrets?
  • What events hold deep personal meaning or life lessons for you? 
  • Who have you learned the most from? 
  • What does spirituality mean to you?

There are many helpful resources online and in book stores to assist you with writing an ethical will. It is important to remember, however, that a side letter or ethical will is not legally binding, and must be coordinated carefully with your estate plan to ensure it does not hamper or contradict provisions in your estate plan. Further, the language you use is vitally important to whether your incentive trust will be viewed as insensitive and controlling, or appropriately encouraging. 

Finally, there is no substitute for expressing your views in person with your loved ones. Consider meeting in person to discuss your plans with your heirs. Both you and your heirs may be pleasantly surprised by what you both learn from each other. And if the first meeting is awkward and uncomfortable, don’t lose heart. Keep at it. Nothing important is gained without hard work.  

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