Incentive Trusts

Recently I was visited by a couple seeking estate planning advice. They had worked hard to develop a successful family business, which they had recently sold. They wanted to pass on their sizable estate to their two children and several grandchildren and minimize estate taxes in the process.

After going over all their options for minimizing taxes in the transfer process, it became clear that they had another major objective. They wanted the wealth that they had created through their hard work and perseverance to go to their children without ruining their incentive to work and achieve their own financial goals.

This couple is not alone. The single wealthiest generation to live is about to pass on an estimated $9 trillion to their heirs. The number of "millionaires next door" continues to grow. It is estimated that the number of households with more than $1 million in investable assets will grow from 2.5 million in 1998 to 3.5 million by the year 2003.

This wealth creates problems for many of those people who created it in the first place. The majority of this wealth was created from meager beginnings through a strong work ethic and a willingness to sacrifice today’s pleasures for tomorrow’s benefits. Passing these values to future generations is just as important as passing on the wealth.

The famous investor, Warren Buffet, quoted in the September 29, 1997 issue of Fortune magazine stated it best when he said: "The perfect inheritance is enough money so that they feel they could do anything, but not so much that they could do anything."

By providing an inheritance to future generations that allows them not to work, you will hurt rather than help them. Estate planning that focuses on the impacts of inheritance and tax issues is beneficial to both generations.

Incentive trust planning can be used to overcome some of the negatives generated by the transfer of too much wealth. An incentive trust is designed to encourage behavior that the estate creator would like to see exhibited by his heirs. At the same time, an incentive trust also restricts the ability of the heirs to live off the inheritance.

The design of the incentive trust will usually contain provisions that provide income as a safety net. Language might express the trust maker’s desires that certain standards of living, education, capital for business development, and health needs be met from trust income first. Excess income not distributed can be allowed to accumulate in the trust and/or paid out to specific charities.

A great deal of creativity can be exercised by the trust maker to provide for other payouts. For example, payouts can be structured to match income goals achieved by the heirs. Perhaps the maker wishes to reward those who obtain certain education goals with payments from the trust.