Because the heirs cannot expect to control the assets, the incentive trust is an effective asset protection tool. An outright inheritance can easily be exhausted due to a lawsuit, overwhelming debt or a bad marriage. With an incentive trust, however, typically no distributions would be made if the assets would end up in the hands of an ex-spouse or creditor. Rather, the trustee would make distributions for the benefit of the beneficiary.
Avoiding Pitfalls
Some
critics argue that an incentive trust does more harm than good. Too
many restrictions on access to the trust assets not only build
resentment among the beneficiaries, but they can make the trust
impossible to administer and may leave the trustee exposed to lawsuits.
The starting point to creating an effective trust that will last for generations is to clearly understand what the trust grantor wants to achieve:
What values does the grantor want to promote?
If the grantor was alive to guide future heirs, how would he or she pass down values or support his or her family?
How would the grantor determine who should benefit from the family's wealth?
How should a beneficiary's success or failure at meeting the grantor's goals be measured?
Think through the incentive provisions carefully by playing out worst-case scenarios. The most successful incentive trust should include terms that will encourage positive behavior, rather than discourage negative behavior. Cutting off the beneficiary who is abusing drugs may seem logical, but will it achieve the intended goal? The beneficiary might forgo counseling to avoid detection of his or her problem.
The grantor also has to understand that he or she can't and shouldn't try to control the heirs' choices of religion, spouses or partners, or careers. Not only won't the courts uphold these conditions, but the conditions may not be in the best interest of a particular heir. As my wise daughter once told me, "Mom, I value your advice but the decision is mine. You have done a good job. Now it is time to let go."
Unfortunately, some children will never have the internal motivation to make a significant difference in the world, and no amount of strings attached to a trust will overcome that. Punishing them by withholding money may encourage litigation. If an heir is cut off, he or she may have nothing to lose by contesting the trustee's decision. Instead of expecting future generations to follow in your footsteps, think about how each heir could be encouraged to reach his or her potential, regardless of what that turns out to be.