Motivating children to make worthwhile life decisions.
Updated: Feb 17
Over the next decade, increasingly large amounts of wealth will pass by gift and inheritance from parents to children. In some cases, the amount that a child might receive from parents will be nominal, but in other cases, the amount may be large enough to be a life-altering event. When parents confront the idea of their children inheriting substantial, life-altering amounts of money, they often have reactions such as:
“We don’t want our children to do nothing with their lives because they are anticipating a large inheritance.”
“We want our children to understand the value of work. We believe that earning your way through life is better than living off an inheritance.”
So, when the amounts that children might inherit are substantial, and parents are concerned about the impact that inheritance will have on their children, what can they do?
Some parents give the family fortune to charity, rather than giving it to the children. Others announce to their children that the children will inherit only a limited amount, giving them advance warning that they should not anticipate a large inheritance.
But what if parents want their children to inherit the entire family fortune? How can the family fortune be distributed to children in a way that doesn’t disable them from becoming productive members of society?
One idea is to give the family fortune to the children in a type of trust often called an “incentive trust.”
The first question: Should the children inherit assets outright or in trust? Most parents decide to give the family fortune to their children in equal shares. The threshold question for many parents is whether to give each child their share of the family fortune outright, or subject their inheritance to a trust. If each child’s amount is expected to be significant, then many parents elect to use a trust. A trust can be designed to protect the inherited assets from additional estate taxes as well as from a child’s creditors (including a child’s divorcing spouse).
In many trusts, the trustee is directed to distribute to the child on a regular basis the net income generated by the trust assets. Typical distributions are made monthly or quarterly. In addition, the trustee is often given the power to distribute any portion of the trust’s principal for a child’s health, education, maintenance and support.
The use of an incentive trust to promote good life decisions. But how can a trust be designed to provide an incentive for a child, especially an adult child, to accomplish certain goals in life and make thoughtful choices for the child and the child’s family? One way is to design a trust that provides the trustee discretion to make distributions of principal from the trust as an incentive for the child to make thoughtful lifestyle decisions, such as pursuing a career (whether financially rewarding or not), raising a family or contributing to the community. These “incentive” distributions to the child could be made in addition to, or in lieu of, the regular distributions of the net income of the trust and distributions of principal for health, education, maintenance, and support.
The selection of trustees. If parents wish to consider the use incentives trusts for their adult children, one of the most critical decisions will be the selection of the proper trustee for the trust. First, the parents must select someone who takes the trustee duties seriously, and who will faithfully follow the wishes of the parents. Second, the trustee who has the power to make incentive distributions of principal should never be the child who is the trust beneficiary, or anyone under the control of that child. Therefore, parents should discuss the selection of trustees for incentive trusts with their estate planning attorney.
Providing guidance to the trustee. When designing an incentive trust, it’s a good idea for the parents to give the trustee some guidance regarding the purpose of the trust, as well as some examples of incentive distributions. Here is sample trust language to that effect:
“It is our desire to encourage our children to achieve personal and financial success in their lives, and to become productive members of their families and their communities. In order to provide each child with an incentive to achieve these goals, the trustee may make additional distributions of principal from this trust to reward a child for his or her life accomplishments and good lifestyle decisions. The trustee may make incentive distributions of principal to reward a child, or to provide an incentive for a child, for any purpose that meets this overall goal. The trustee is not required or mandated to make incentive distributions to a child for any particular reason, and the trustee may not be compelled by the child to make any incentive distribution to the child. Instead, we ask the trustee, in the trustee’s sole discretion, to determine when, and if, such incentive distributions should be made from this trust to a child. In order to assist the trustee to determine when, and if, an incentive distribution of principal may be appropriate, we list below some guidelines for making these distributions.”
Examples of incentive distributions. Here are examples of provisions that could be included in incentive trusts for adult children:
To assist a child to acquire or improve the child’s primary residence, especially if the child makes a contribution of funds or personal efforts toward the acquisition or improvement of the property.
To assist a child to establish or maintain the child’s business or professional practice.
To match a child’s personally earned income in any calendar year. (This provision can be designed to limit the amount that will be matched by adding language such as “but not to exceed one hundred thousand dollars ($100,000) in any year.” Also, some parents may want to require that only earned income will be matched, but not unearned income, such as income from investments.)
To match a child’s financial contributions to charity. (As above, many parents wish to limit the amount that could pass to a charity through this matching provision. In addition, parents may want to require that the child actively participate in any charity to which matching contributions would be made, asking that the child serve on the board of the charity for a certain number of years before such matching contributions would be made.)
To reward a child for career accomplishments, especially if the child’s career is not one that provides significant financial rewards. For instance, if a child is an artist, a schoolteacher or a nurse, but the child does not earn a significant salary, then the trustee is encouraged to make distributions of principal to reward the child for his or her dedication to, and advancement in, the child’s career.
To acknowledge and reward a child’s efforts if the child is pursuing an educational, scientific or charitable goal that is beneficial to the child, the child’s family or the child’s community.
To recognize and reward a child’s contribution to raising a family, especially if the child is caring for children or other close relatives and that obligation precludes the child from earning a living outside the home, from working full-time or from pursuing a financially lucrative career.
To supplement a child’s income if the child is ill or disabled, or if the child is caring for a family member who is ill or disabled.
To supplement a child’s other sources of support during retirement years. (Here, some parents limit when these distributions would be made, requiring that the distributions may begin only after a child reaches a certain age, such as 65.)
An incentive trust can be designed to fit each family’s particular situation. Some trusts may provide for broad, liberal distributions of trust principal which would essentially distribute the entire trust to the child over a short number of years. Other trusts may provide for stiff requirements before a child receives an incentive distribution, assuring that the trust will last for the child’s lifetime and beyond.
Most importantly, the parents should be very involved in the design of the trust in order to insure that it’s the right trust for their family.
~ Contributed by Katherine Ohlandt