Estate planning isn’t just about sharing wealth with the younger generation. For many people, it’s equally important to share one’s values and to encourage their children or other heirs to lead responsible, productive and fulfilling lives. One tool for achieving this goal is an incentive trust, which conditions distributions on certain behaviors or achievements that you wish to inspire.

Incentive trusts can be effective, but plan and draft them carefully to avoid unintended consequences. Let’s examine four tips to consider when designing an incentive trust.

1. Focus on positive reinforcement

Avoid negative reinforcement, such as conditioning distributions on the avoidance of undesirable or self-destructive behavior, for example, gambling or drug use. This sort of “ruling from the grave” is likely to be counterproductive. Not only can it lead to resentment on the part of your heirs, but it may backfire by encouraging them to conceal their conduct and avoid seeking help.

Trusts that emphasize positive behaviors, such as going to college or securing gainful employment, can be more effective. Plus, accentuating the positive tends to discourage negative behavior; it’s difficult for a substance abuser to stay in school or hold down a job.

2. Be flexible

Leading a worthy life means different things to different people. Rather than dictating specific behaviors, it’s better to establish the trust with enough flexibility to allow your loved ones to shape their own lives.

For example, some people attempt to encourage gainful employment by tying trust distributions to an heir’s earnings. But this can punish equally responsible heirs who wish to be stay-at-home parents or whose chosen careers require them to start with a low-paying, entry-level job or unpaid internship. A well-designed incentive trust should accommodate nonfinancial measures of success.

As you think about the incentives you wish to provide, avoid the temptation to “buy” desired behavior. Suppose, for example, that your trust provides generous distributions to a daughter who cares for her children full time. But what if she really wants to work outside the home? If the “stay-at- home bonus” is too large, she may feel she has little choice. A better approach is to reward your heirs for a variety of positive options and allow them to choose their own paths.

3. Consider a principle trust

Drafting an incentive trust can be a challenge. Rewarding positive behavior requires a complex set of rules that condition trust distributions on certain achievements or milestones, such as gainful employment, earning a college degree or reaching a certain level of earnings. But it’s nearly impossible to anticipate every contingency.

What if your heir becomes disabled and can’t work or chooses to be a stay-at-home parent? What if your heir takes a low-paying job with a charity or not-for-profit organization? What if your heir forgoes college to pursue a worthy vocation, such as construction or auto repair? On the flip side, what if your heir becomes a “professional student,” using the trust funds to pursue one impractical college degree after another?

One way to avoid unintended consequences is to establish a principle trust. Rather than imposing a complex, rigid set of rules for distributing trust funds, a principle trust guides the trustee’s decisions by setting forth the principles and values you hope to encourage and providing the trustee with discretion to evaluate each heir on a case-by-case basis. Bear in mind that for this strategy to work, the trustee must be someone you trust to carry out your wishes.

4. Provide a safety net

An incentive trust need not be an all-or-nothing proposition. To keep your heirs off the street, offer sufficient funds to provide for their basic needs and base additional distributions on the behaviors you wish to encourage.

A balanced approach

According to Warren Buffett, the ideal inheritance is “enough money so that they feel they could do anything, but not so much that they could do nothing.” A carefully designed incentive trust can help you achieve this goal. Talk to your estate planning advisor for more details.

© 2022

Disclaimer: The THK Legal Blog is for informational purposes only and should not be relied upon as legal advice. In no case does the published material constitute an exhaustive legal study, and applicability to a particular situation depends upon an investigation of specific facts. You should consult an attorney for advice regarding your individual situation. All THK blogs are considered advertising material by the Indiana Bar Association.