FAMILY INCENTIVE TRUSTS

If you are a parent who has been successful creating and saving wealth, you might be debating how you can ensure that passing your wealth on to your children or grandchildren does not negatively impact their development into contributing and responsible adults. Or perhaps you have heirs who have been financially irresponsible or who have drug or alcohol problems and you don't want to support such behavior.

While some people believe that they should not try to direct how their money and assets are used after their death, contending that it is wrong to "rule from the grave", others believe that they have a right, and perhaps a duty, to ensure that their wealth doesn't create generations of non-productive heirs, living only on inherited wealth with no incentive to lead productive and useful lives. One option for these people is to leave their wealth to charities that have goals that the giver appreciates. Another option is to create a trust with provisions designed to give incentives to heirs to engage in certain types of behaviors or fulfill certain goals.

Generally, if both parents die when their children are minors and they leave money or property to their children valued at more than $5,000, a legal guardian over the estate must be appointed by the court who manages and controls the money and property until the child is 18, absent extraordinary circumstances. When the child turns 18, the child obtains unrestricted access to their inheritance. Even a relatively small estate of $400,000 could have a large impact on a child who would receive unrestricted access to the funds at age 18. Often parents do not realize that if both parents die, their life insurance proceeds and pensions will go to their children who will also receive unrestricted access to such funds when they are 18 years old. It is certainly true that the receipt of large sums of money and the expectation of such receipt, can cause many children to lose their drive to go to college, to get a job, or to undertake other activities that have as the ultimate goal, earning a living.

A typical incentive trust is set up by parents whose children are minors or young adults. The parents create an estate plan that is only to take effect at the death of both parents. Most of these plans are created through a revocable living trust. Generally, these parents don't believe that it is in their children's best interest to obtain unrestricted access to their inheritance when they turn 18 years of age. Therefore, they create a plan that sets aside the inheritance in a trust. While the children are minors, the Trustee is instructed to ensure that the guardians of such children have sufficient money to pay for the children's support, health and education. After each child reaches 18 years of age, the Trustee is instructed to use the funds to pay for certain activities or provide certain incentives to the child, depending on the parents' desires. Some of the types of activities and incentives might include: paying for college or other post-secondary education and giving a lump sum distribution upon graduation; providing funds for a down payment to purchase a home; making a loan to enable a child to start or buy a business; or providing living expenses to allow a child to undertake non-profit, religious or charitable work. The goal of these requests is to encourage the responsible use of the funds and the encouragement of the child's responsible behavior. These plans may instruct the Trustee to withhold funds from any child who exhibits irresponsible or abusive behavior and may allow the Trustee to pay funds to provide assistance to children with health or other disabilities. While the parents' preferences may set the types of behaviors they wish to encourage, often the parents allow the Trustee the flexibility to use the funds to encourage other behavior consistent with the parent's overall goals. The majority of these trusts are scheduled to terminate and the Trustee is requested to distribute the balance, or a percentage of the balance of each child's share of the trust, at certain ages. In my experience, the ages at which parents decide to distribute lump sums to their children varies a great deal, depending on the parents' personal experiences, the amount of money expected to be in the trust, and the parents' goals. Where the primary goal of the parents is to encourage their children to go to college, many of my clients chose to distribute lump sums commencing graduation or at 25 years of age, whichever is earlier, and continuing each 5 years terminating at 35 years of age.

People with larger estates with estate tax issues or those who want to provide for their grandchildren and possibly great-grand-children, might use a similar plan to set up incentive trusts designed to maximize the use of the transferor's generation skipping transfer tax exclusion.

The Incentive Trust may be used to set aside money and assets for grandchildren and great-grandchildren, many of whom may not be born at the date of the transferor's death. The Incentive Trust provisions assure the transferors that their intention to provide for subsequent generations does not have the unintended effect of creating generations of unemployed and un-productive heirs living the good life off of inherited, not earned, money.

If the Trust is set up under California Law, the generation skipping Incentive Trust must terminate 21 years after the death of all of the beneficiaries living at the date of the transferor's death. However, many of these trusts are set up using the laws of states that have no such termination requirement. Regardless of the state law used, these trusts are useful for transferring assets through several generations without estate tax being assessed at each generational transfer.

If you would like more information about Incentive and Generation Skipping Trusts, feel free to contact Michelle Noble McCain at 106 Central Avenue, Salinas, California, 93901 (831) 772-8300.


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