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Incentive Trust: Estate Planning Tool to Encourage Financial Responsibility

Learn about incentive trusts and how they can encourage beneficiaries to make better financial decisions.

As you begin thinking about your Estate Plan and who you want to leave your assets to, you may be wondering what your options are for leaving your children and loved one’s inheritance. It is possible you may be wishing that you had the option to bequeath your children money, but only if they have reached a certain milestone, such as completing a college degree, getting their first job, or having their first child. If this is something on your mind, you are in luck! One option available to you is creating an Incentive Trust.

Here at Trust and Will, we want to help make sure that you are aware of all of the options available to you when leaving your loved ones money after you pass away. In this article, we will focus on Incentive Trusts, what they are, how to create one, and the rules that accompany Incentive Trusts. 

What is an Incentive Trust?

To understand what an Incentive Trust is, you will first want to understand what a regular Trust is. A Trust is when you pass the ownership of a specific asset onto another individual, known as your Trustee. 

An Incentive Trust is when a Trust is created specifically to either encourage or discourage specific behaviors/actions of the person to whom you are leaving the Trust assets, known as the beneficiary. For example, you could state that the beneficiary will only receive a portion of the Trust once they have graduated and will receive another portion after a different designated life milestone. Conversely, you could say that the beneficiary will only receive the assets once they have successfully completed AA or gone to an addiction treatment facility. The asset that is commonly portioned off in an Incentive Trust is money, often your children’s or grandchildren’s inheritance. 

What are the Roles in an Incentive Trust?

  • Settlor: The creator of the Trust who is passing on ownership of assets.

  • Trustee: The individual who is chosen by the settlor to be responsible for the assets within the Trust until they are passed on to the new owner.

  • Beneficiary: The person who will receive the assets of the Trust once they have completed the necessary requirements to obtain ownership of the assets.

How Does an Incentive Trust Work?

Incentive Trusts, commonly used to encourage financial responsibility, are initiated by the Trust Settlor who leaves an official set of designated written rules that are legal and binding. These rules stipulate the actions that need to be completed by the beneficiary in order to receive the assets of the Trust. In the interim, before the actions are fulfilled, the chosen Trustee is responsible for the assets within the Trust. As the necessary actions are completed by the beneficiary, they will receive the assets of the Trust. Once all assets of the Trust have been passed on in ownership to the beneficiary, the Trust will be closed.

Pros and Cons of an Incentive Trust

Incentive Trusts are beneficial for people who want to encourage their children or grandchildren to complete a certain life milestone, prior to accessing the funds set aside for them in their Incentive Trust. Some Settlors believe this may be helpful in trying to encourage a child to complete a college degree, as you could specify that the money may only be used for their education, or specifically toward obtaining a college degree. 

Another pro is that an Incentive Trust ensures that you have some control over how the money or other assets are used, even beyond the grave. It may be important to you that your children do not squander their assets on things that you feel are not beneficial to them. An Incentive Trust can help ensure that you know your money is being used in a way you feel is appropriate.

One con of Incentive Trusts is that you need to be careful about wording the instructions you leave behind, as they are legally binding. If you are not careful, it is possible that your instructions could be misinterpreted, leaving your beneficiary without access to their assets when they need them. Alternatively, if you are not concise, then your beneficiaries could try and find loopholes in your rules.

An additional con is that some may not feel comfortable with the idea of having this level of power over another’s life, even after death. For example, you may have wanted the beneficiary to get a college degree, but instead, they may have a desire to attend a trade school. Or, maybe they have other goals not relevant to a college degree that they want to pursue in accordance with their definition of a successful and happy life. Furthermore, a physical illness may prevent the beneficiary from completing a college degree in their lifetime. In these situations, they would lose access to their assets, which can be frustrating and stressful in certain circumstances.

Example of an Incentive Trust 

One example of an incentive Trust in action is in the case of the Lazaruses who created an Incentive Trust for their children, as they believed that giving their children too much money at once could negatively impact them. Instead, they tied portions of the money to certain events in their life, including their children’s graduation and their wedding days. This was a Jewish tradition that they wanted to pass down to their children. 

Deciding how you want to split up your children’s inheritance and when you want them to receive their inheritance can be a challenging and time-consuming decision to make. Trust and Will wants to simplify the process by making the creation of your Estate Plan quicker and more efficient. That is why we created our online Estate Planning services that allow you to create and download your state-specific Will, Trust-Based Estate Plan, Nomination of Guardian documents, and other legal Estate planning documents all from your computer. If you are unsure where to start, take our free online quiz. Get started today!