Tips for handling the transfer of funds from one generation to the next
An incentive enables parents or grandparents to financially reward heirs for desired behaviors.
Make sure your trustee is fully aware of your trust’s intentions and how the funds should be distributed.
Incentive trusts allow you to transfer assets to the next generation in stages—rather all at once—pending the beneficiary’s ability to reach certain life milestones.
Sometimes parents want to leave funds to their children, but they are concerned that their kids may not be responsible enough to manage those funds. Other parents or grandparents wish to ensure that inherited funds do not cause the beneficiaries to become lazy, financially reckless, or unproductive citizens.
To address this concern, funds from trusts are often distributed in stages, such as one-third at age 30, one-third at age 35 and one-third at age 40. For other families, in which the children are already somewhat older, but perhaps the parent is not fond of the in-laws, the funds can be distributed at intervals such as 50 percent upon the death of the parent and 50 percent five years later but not exceeding a date later than when the child attains the age of 65.
Parents and grandparents are typically concerned about education, morals and family values, business and vocational choices, and charitable and religious opportunities. In these types of situations, a parent or grandparent may want to establish what is known as an “incentive trust.” An incentive trusts allows the grantor of the trust to reward heirs for desired behaviors. Likewise, incentive trusts can be structured to penalize heirs for engaging in undesirable activities.
Incentive trusts may be used to provide extra support to the heirs who pursue advanced degrees or who focus on family life. For instance, the trust could be designed to provide enough income for an heir’s family so that only one of the two parents needs to work, thus enabling the second parent to stay home with the heir’s children until those children attain a particular age. There also may be a trust designed to provide funds to heirs who are committed to maintaining the family business, and additional financial support may be provided to beneficiaries who choose to work in lower-paying, but highly rewarding professions that help people, such as social service or teaching.
Finally, some family members may wish to encourage certain behavior in their heirs by requiring specific observances such as religious or charitable opportunities. So, if heirs are involved in a particular cause, such as missionary work, the trust fund will provide them with additional support for themselves and their families. And, they won’t have to worry about requesting additional funds from the trustee on a periodic basis.
When setting up an incentive trust, it is very important that the trustee is aware of the intentions of the grantor. Therefore, in addition to the usual provisions (such as having all income distributed with principal at the discretion of the trustee), the trustee should be given specific authority within the trust, and possibly even a letter of intent from the donor, explaining when and how much of the funds are to be distributed at any given time. It is also important to ensure that the trust does not violate any constitutional or public policy law or standard that would cause the trust to be in violation of a statute or regulation.
In short, it is easy to discuss the establishment of an incentive trust, but there are significant and complex legal, tax, and investment issues that also will arise when creating this type of document. Incentive trusts are not for everyone, and they should be used only in situations in which other types of trusts or investment vehicles are not appropriate. Always consult your advisors before setting up a trust. Contact us any time if you, or someone close to you, is interested in the possibility of setting up a trust to benefit future generations or causes you believe in.
Robert J. Pyle, CFP®, CFA is president of Diversified Asset Management, Inc. (DAMI). DAMI is licensed as an investment adviser with the State of Colorado Division of Securities, and its investment advisory representatives are licensed by the State of Colorado. DAMI will only transact business in other states to the extent DAMI has made the requisite notice filings or obtained the necessary licensing in such state. No follow up or individualized responses to persons in other jurisdictions that involve either rendering or attempting to render personalized investment advice for compensation will be made absent compliance with applicable legal requirements, or an applicable exemption or exclusion. It does not constitute investment or tax advice. To contact Robert, call 303-440-2906 or e-mail firstname.lastname@example.org.
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