Estate planning: How to create an incentive trust

Dear Savvy Senior: What can you tell me about creating an incentive trust? I have an adult son and daughter who are financially inept. Before I die, I want to put some type of requirements in place that they will need to follow in order to receive their portion of my estate. — Frustrated Father

Dear Frustrated: If you want to influence your heirs after you are gone, an incentive trust is definitely an option to consider, but be careful how you construct it because such trusts can cause unintended, unfair consequences. Here’s how it works, along with some tips to help you create one.

Incentive trust basics

An incentive trust is an estate-planning tool designed to help encourage certain conduct by your heirs.

With an incentive trust, some or all of your assets are passed to your trust when you die rather than directly to your heirs. Your trustee is empowered to distribute funds only if your beneficiaries do what you have specified.

For example, an incentive trust might encourage a beneficiary to graduate from college, enter a particular profession, get married or even have children. Or it could penalize beneficiaries who don’t work by cutting off or decreasing distributions or placing restrictions on heirs with addictions by requiring that payments go directly to rehab centers.

But be aware that these types of trusts can also have drawbacks. For example, if your trust provides a financial incentive for your children to be employed full time, but one of them gets sick or seriously injured and can’t work, they would be punished unfairly.

You also need to know that incentive trusts aren’t cheap. You can expect to pay an attorney $2,500 to $5,000 to draft one.

There are also legal limits on what you can do with an incentive trust. While state laws vary, incentive trusts that encourage a beneficiary to join or leave a particular religion, or leave a spouse or not marry at all, can be challenged in court and possibly struck down.

How to create one

To create a solid incentive trust that accomplishes what you envision, you need to hire an estate-planning attorney who will include precise instructions. You’ll also want to include language granting your trustee the right to use his or her discretion and that the trustee’s decisions should be final and binding.

This allows your trustee to make common sense rulings, which will reduce or eliminate the chances of unintended and unfair consequences. It also makes it very difficult for beneficiaries to successfully challenge the trust or trustee in court.

The key is to select a trustee who’s smart enough to interpret your intent and has sufficient backbone to stand up to beneficiaries. You also need to select a successor trustee in case your first choice can no longer serve. Fees paid to a trustee vary widely depending on the state’s fee schedules, the size and complexity of the trust, and conditions laid out in the trust.

To find an experienced attorney in your area to help you create an incentive trust, see the National Academy of Elder Law Attorneys (naela.org) and the American College of Trust and Estate Counsel (actec.org).

Send your senior questions to: Savvy Senior, P.O. Box 5443, Norman, OK 73070, or visit SavvySenior.org.