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Use incentive trusts to reward, not punish

When it comes to your estate, planning ahead is critical. Today, I want to talk about an estate tool worth considering. I'm referring to testamentary incentive trusts.

The trust

A testamentary incentive trust is simply a trust that is created at the time of your death, by your will. The trust, however, is different than others in that it's designed to encourage certain beneficial behaviour by your beneficiaries, and to perhaps discourage other negative behaviour. How? By attaching strings to distributions from the trust.

The provisions you include in an incentive trust are limited primarily by your creativity. What provisions are most common? Consider these five.

Education. The incentive provisions of the trust might reward the beneficiary for earning a degree, achieving a certain grade point average, or attending a particular school. Keep in mind, though, that not every kid is cut out for Harvard, medical school, or straight A's. Making some distributions for each year completed may be a greater incentive than holding back distributions until the degree is complete.

Career. Incentive provisions can reward a beneficiary for career productivity by making distributions when the beneficiary remains employed. Or you can reward a beneficiary who chooses to take ownership, or work in, the family business. You may even choose to make distributions from the trust that equal the income earned by the beneficiary each year.

Of course, you should realize that this may promote productivity in your heirs, but it might also sacrifice career satisfaction. Your child might have a heart for social work, but may choose a higher-paying career in order to receive greater distributions from the trust.

Charity. You may want to encourage your beneficiaries to be involved in the community or to give to charity by rewarding this behaviour. The incentive provisions could allow distributions from the trust equal to amounts donated by your beneficiaries to charities. The trust could also provide additional income to a beneficiary in a lower-paying career, such as social work or a religious calling.

Family. Some people have rewarded a child with distributions from the trust if the child stays married. Others have rewarded a spouse who stays home to take care of the family's children. All of this is possible, albeit controversial, I understand.

Health. Incentive provisions can permit greater distributions from the trust if beneficiaries stop smoking or drinking, avoid drugs, participate in certain rehab programs, lose weight, or refrain from destructive or illegal activities.

The issues

Now hold on. I know that some of you are probably hot under the collar at this point. The idea of trying to control the behaviour of a child beyond the grave is reprehensible to some.

The key with an incentive trust is to use it in a prudent, sensitive manner. It should be used to reinforce the values that you have already instilled in your heirs. Business psychologist David Lansky, in Deerfield, Ill., says that reaction to trust restrictions can be strong resentment, or even hatred, when a beneficiary feels that the trust's restrictions are unfair. In this situation, the beneficiary may even "overvalue the action that was unfairly restricted," according to Mr. Lansky. It may be irrational, but it can happen.

Use the trust to reward a wide range of behaviour or achievements, not to punish behaviour you consider wrong. It's important to avoid interfering with your beneficiary's freedom or disrupt close family relationships. You should sit down with your beneficiaries and discuss the incentive provisions before finalizing your will.

By the way, incentive trusts are most effective for beneficiaries between the ages of 20 and 40. Incentive trusts are generally intended to reward maturity and productivity in your kids.

By the time your child is age 40, they're about as mature as they're ever going to be, so the theory goes. This is not to say that testamentary trusts are ineffective for those over 40. There are tax benefits to these trusts as well (see my article from Sept. 27, 1997 at http://www.timcestnick.com). I'll finish this discussion of incentive trusts in my next article.

Tim Cestnick, FCA, CFP, TE,P is author of Winning the Tax Game 2004, and The Tax Freedom Zone. He is managing director, national tax services, at AIC Ltd.

tcestnick@aic.com



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