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December 11 2008

Incentive Trusts

By Neil L. Kimball

A living Trust is an estate planning vehicle that allows you to transfer assets to the Trust during your lifetime typically to be managed for your benefit by you as the initial Trustee during your lifetime. Upon your death, the Trust would typically provide for distributions to children or other beneficiaries. If you transfer assets to the Trust during your lifetime, those assets will avoid probate proceedings at your death. Trusts can also avoid or minimize estate taxes for married couples who have larger estates.

Another important aspect of Trusts is their flexibility in managing assets for beneficiaries who might not otherwise be able to manage assets. For example, parents might create a trust to manage assets for their minor children over time to provide for their college and provide distributions outright to them when the children attain various ages and presumably have a greater degree of maturity and financial acumen. However, some clients have children who, although they are adults, have shown very little financial acumen or even a desire to become employed. In those situations, a living Trust can manage the assets for those children and can place conditions on the child receiving distributions from the Trust. These trusts are sometimes referred to as "Incentive Trusts."

An easy example would be the parent who provides in their Trust that upon their death, a share is set aside for the parent's son. The Trustee is instructed to invest the assets of the son's share and provide the son with distributions of Trust income and principal but only to the extent that the son produces proof to the Trustee that he has earned income through employment. Under this arrangement, the Trust would provide an incentive to the son to get a job and earn money. The son would then provide proof of earnings to the Trustee who would make a matching distribution. For every dollar the son earns, there is a dollar distribution from the Trust. If the son doesn't work, the son does not receive any distributions from the Trust.

The parent might also provide that if the son is unable to work in the future because of disability, inability to work, or because he is caring for children of his own, the Trustee would still have the discretion to make distributions to the son. The Trust might also provide that if the son refuses to work for a certain period of time, then the balance of the Trust for the son is distributed to another beneficiary or to charity.

There are numerous creative provisions that can be added to Trusts to provide incentives to beneficiaries to act more responsibly.