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You can make an inheritance contingent on very specific behavior. But will "ruling from the grave" truly let you rest in peace?
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You can make an inheritance contingent on very specific behavior. But will "ruling from the grave" truly let you rest in peace?
Do you ever worry that your children or grandchildren might waste their inheritanceor that it might waste them? Does it disturb you to think of leaving them money when you're not sure what lifestyle it might support?
Then maybe you'd like to keep the inheritance tied up, not just in a trust, but in one that says, "Here's money for collegebut only if you maintain at least a B average." Or: "Each year, you'll get an amount matching the salary you earn." Or: "You'll receive these thousands, as long as you stay home to care for your children." Today, some advisers are getting a lot of press by suggesting such approaches, in so-called "incentive trusts."
Of course, the basic concept is hardly new. Dozens of old plays and movies revolved around requirements that characters had to meetoften quirky ones, like marrying or not marrying a particular personin order to inherit. And in real life, estate planning often gives trustees much discretion to decide when and how much money to distribute to beneficiaries. However, including specific clauses to guide heirs' behavior or lifestyle seems to be an increasingly popular approach.
Is the incentive trust concept a good one, or an intrusive "ruling from the grave"? Let's take a look, and see why it makes sense to consider this technique, even if you think you'd have no interest in using it.
"You can never be too rich or too thin," the aphorism states. Doctors know only too well that it's possible to be too thin. And the rest of the saying is equally off-base: Too rich is not only possible, but destructive. "Wealth can make people self-indulgent and lazy," says attorney John J. Scroggin of Atlanta, who focuses on incentive trusts. "That's why Bill Gates and other billionaires keep asserting that they don't want to leave their heirs fabulously well-off."
You needn't be a billionaire to be concerned about passing on excessive wealth, notes lawyer Scott McCue of Chicago. "Many, many clients are worried about leaving too much to their children. They don't want to leave money in a trust whose trustee can simply give the kids whatever they want, he observes."
This often combines with another concern about children, one that may not be new but seems increasingly common, adds Robert Goldman, an attorney in San Francisco: "Among the affluent today, the drug culture is another reason a lot of parents are very concerned about whether their kids will lead productive lives."
"In the past, estate planning has been focused too narrowly," says broker and planner Robert Littell of Atlanta. "We'd concentrate on reducing taxes, but not on what you'd like the money to be used for or, more important, how you could leave wealth in a way that would build character, not destroy it."
What kinds of goals might a trust aim for? One common provision promises matching funds for earned income. Those who do well financially will be rewarded, and those who don't, won't. That may seem a good ideaif, say, you're trying to avoid subsidizing a son's ski-bum tendencies. But suppose you have two pre-med daughters, and after you die, one specializes in Hollywood face lifts while the other helps refugees in war zones. Your clause would penalize the second for her altruism. And suppose you write the clause while your heirs are in elementary school?
With such contingencies in mind, you might try to refine your stipulations. "To avoid depletion, if your trust may be paying out to a high earner, you might match only 50 percent of earnings, maybe with a dollar cap, too," says Scroggin. Attorney David J. Schiller, of Norristown, PA, suggests another approach: "You might avoid unfairness yet achieve your goals by using broader language. Consider providing equal distribution among all heirs who are 'productive members of society,' for example."
Or perhaps you feel that the lower earners in your familya minister, say, or a writerdeserve extra help. "Then you might have a reverse match," says Scroggin. "Heirs who earn less would get a higher matching percentage. One of my clients, a former schoolteacher, has provided matching only for heirs who are teachers."
Another common provision, Scroggin says, involves a special disbursement for an heir who stays at home to care for a child. "We've included this in about 200 plans, with the annual amount typically in the $50,000 to $70,000 range, he says." But that, too, might be problematic, as McCue notes. "Suppose you have a hardworking child in a two-doctor marriage, struggling to establish both a career and a family," he posits. "This trust's provision strongly implies that you think your child isn't doing an adequate job as a parent. Do you really want to leave that impression?"
One way to avoid any possibility of sending the wrong message is simply to encourage good behavior in a nonspecific way, perhaps by offering a ''family Nobel Prize'' of a certain amount, Scroggin says. It could be awarded at certain intervals to an heir who has made the most significant contribution in medicine, the humanities, or any field you specify.
By far the most common form of bad behavior trusts try to constrain is abuse of drugs, including alcohol. Even attorneys such as New York's Gideon Rothschild, who doesn't particularly favor incentive clausesor disincentive clauseshave used language in trusts specifying that heirs will get money only if they're drug-free and ready to prove it by submitting to tests. "I've included these provisions for years," Rothschild notes. McCue also doesn't usually suggest the incentive approach, yet he recommends the drug provision, albeit as a last resort: "It works. Of course, the testing aspect is humiliating, but I know of a case where an heir got off drugs and stayed off, in order to have the trust money."
You might even be able to accomplish your goal without requiring periodic testing, Scroggin notes. "One client wanted drug testing every month. But in this case, it seemed extreme. I suggested instead that the trustees be given the right to request testing if they ever suspect abuse has occurred. A beneficiary who then refuses will lose benefits until he or she agrees. If the testing proves positive, that heir must go into a detox program." To prevent an endless loop, he adds, "you might allow for cutting off trust money completely after going through this routine 10 times or so."
Another way to discourage certain behavior is to reward its absence. For example, some clients of Scroggin wanted heirs to forfeit income for any traffic violation involving drugs or alcohol. "But I thought it might work just as well to provide a bonus for every year there is no such violation, he says."
One of Scroggin's clients used the "just say No" approach to address a different sort of concern. "He grew up poor and rural," Scroggin recalls. "A favorite cousin had three children by age 19, and my client felt the early responsibility had greatly restricted her life. To keep his own children from following the same path, his trust provides that up to age 23, his heirs will get an extra $5,000 for every year they don't have children."
Incentive trusts leave some planners very skeptical. "You can't foresee everything," says Teaneck, NJ, estate-planning attorney Martin Shenkman. "Suppose I'm one heir, working hard to set up my own business, pouring money into it. My income might be the lowest of the children, yet I might be the hardest-working. Maybe my older brother earns $200,000from making porn films. In a trust that rewards financial success, he deserves money, and I don't. I wouldn't want those rules for my kids."
If you do decide to draw up rules to live by, allow leeway for the unforeseen, and use common sense. And don't assume that your lawyer will make sure you've covered all the bases. Take a good, close look at the final product yourself. "One new client came in to have his earlier estate plans reviewed, because he knew he had a fatal illness," says McCue. The man's former lawyer had set up a trust with a very strict income-matching provision: His heirs would get disbursements equal to what they earned. McCue, mindful of the client's illness, then asked about one seemingly obvious exception. "But I assume they get a certain minimum anyway, if they're too sick to work?" It turned out that possibility had been overlooked, so McCue added it. "The omission would have been startling in any case," McCue adds, "but here it was especially so, since the client's disease was one that's often passed down."
Scroggin, too, notes that being rigid can be a danger, especially since you can design trusts to last indefinitely (by locating them in one of the states that permit this). "One client wanted a lot of provisions to get heirs to go to college, and then wouldn't allow them any income until age 40, and finally made no exceptions for emergencies. I refused to draft that one," he says.
Allowing for a crucial minimum is a key idea, Scroggin notes. In fact, it may be essential if an incentive trust is controlling a large part of your estate. After all, you may want to provide guidance for your heirs, but you probably wouldn't want anyone to become destitute. "At the minimum, you might want to allow funds to be used for a safety net of essentials, say to pay medical, educational, and long-term care expenses for needy heirs," Scroggin says. "And if an heir ends up with almost no other income, you'd probably want to make trust money available for basic support even if this heir hasn't heeded all the strictures your trust laid out."
Naturally, that requires care in drafting. "You don't want an heir to use that provision just to avoid working," Scroggin says. "That means you might require proof of need."
Trying to guide heirs through specific aspects of the future can be convoluted and may even lead to wrong choices. Robert Goldman, the San Francisco attorney, typically recommends that very wealthy clients set up arrangements that are more elaborate than trusts, but not so specific in their requirements. Usually that means working with family limited partnerships or foundations. "With those approaches, heirs receive training in management," Goldman says. "Instead of being ruled by a trust arrangement, they earn the right to help run things."
Goldman is critical of incentive trusts that set up specific performance criteria. One point he makes is that the amount of detail needed may become impractical: "Take that 'go to college' requirement. To exclude mail-order degrees, you might specify 'accredited' college. Then maybe require a four-year school. And at least a B average at that school." Still, a student might meet all those requirements, yet in a way you'd never approve ofby majoring in the history of pop music, say, at a known party school. "It would be tough to prevent that, unless you start listing acceptable courses of study," Goldman notes. "And then where does it end?" You might wind up with a trust as long as the tax code.
Beyond all that, you might create a very sad situation if your trust assumes that a bad student is a lazy one, adds Goldman. "Maybe an heir is no scholastic whiz and simply can't do better than a C. Or he'd be happier taking vocational or business training. Would you really want a penalty to apply?"
A sophisticated incentive trust, Goldman says, would be value-basedproviding a broad set of guidelines, rather than specific objectives. The "requirements," Goldman suggests, could be that an heir live a productive life or demonstrate responsibility. After all, provisions that tie benefits to academic success, like those dependent on financial success, may keep moneyand encouragementaway from those heirs who need them the most.
When you use relatively uncommon trust provisions, you increase the danger that your ultimate estate plan may be hammered out posthumously, by a judge's gavel. Since incentive provisions often don't have a long tradition behind them, advisers frequently can't say with assurance which ones will be enforced, except that the criteria that seem to fit "public policy"i.e., what our culture generally favorsstand the best chance of holding up.
Okay, then, you needn't fret about the validity of clauses designed to curtail drug addiction or to reward gainful employment. And since society favors marriage, provisions that encourage it may well be permissible. Thus, many attorneys think it might be defensible to encourage marriage within a religious or cultural group ("$5,000 if you marry a Yalie . . . "), yet it might not be enforceable to discourage wedlock with a member of a group (". . . but not a penny if you wed a Harvard man"). Similarly, you can provide an incentive for an heir to marry, but not to divorce ("$3,000 if you leave Fred").
Besides the state, heirs or would-be heirs might also attack your trusts, so be sure to look at your provisions as if you were someone who'd be restricted by them. One approach is to put in a "no contest" clause, which says that if an heir legally challenges the trust and loses, that heir will be cut out entirely.
Even in traditional trusts, you might allow trustees "sprinkling powers," which give them discretion to decide that one heir needs more money than anothersay, because of illness. Discretion means power, of course, which means the possibility of conflict with heirs. And with incentive trusts, trustees may be particularly on the hot seat. First, by their nature these trusts may cause conflicts, since they're written to control heirs' behavior.
Beyond that, squabbles may arise if you give trustees power to modify a trust's terms. Why do that? Perhaps because these trusts may go on indefinitely. "If you'd set one up 40 years ago, $200 spending money a month might have been plenty for a college student," says Scroggin. "But now it wouldn't be. Besides, who knows what kinds of institutions will be acceptable years from now? You have to allow for changes along the way."
Moreover, often the trustees' role is not just to protect trust assets but to protect the family, and that's a broad role requiring extra judgmentand probably extra diplomacy. They may be enforcing some very specific trust provisions, but they also need to take on an almost parental responsibility. To avoid putting too much pressure on one person, it may be better to name two family members as trustees.
In any case, every adviser we talked to recommended having at least one nonrelative trustee, probably a professional (from a bank, say). One reason: You need a trustee with enough experience to handle the complexity involved. "You're probably asking your trustees to make a lot of tough decisions, and there may be some liability," says attorney Lee J. Johnson of Mount Kisco, NY. "You need professionals along."
You need to protect the trustees, too, Johnson adds. That means more than just having the trust state that trustees aren't personally liable for their actions, notes Scott McCue. "You should specify that if they're sued, the defense costs will be paid by the trust. And if a plaintiff loses, the expenses should be charged against that person's share of the trustwhich should prevent frivolous suits."
To some people, incentive trusts are simply a way to guide their heirs and encourage good behavior. "When people give money to charities or set up scholarships, they often write in some criteria governing how the money is to be used," says Robert Littell, a broker and planner in Atlanta. "Incentive trusts just apply the same concerns to your own familyand where better to instill the values you care about?"
But some estate planners are harsh critics. "Often, these trusts get set up by people who fear that they've failed to do their jobs as parents," says Teaneck, NJ, attorney Martin Shenkman. "They feel guilty, and they're trying to get this piece of paper to achieve what they couldn't do."
Perhaps you agree with Littell, or maybe you're in Shenkman's camp. Either way, it makes sense to at least think about incentive trusts. Even if you don't take this approach, just considering it can broaden your thinking and help you craft a plan that's more likely to accomplish your goals. Consider:
Equalizing. "Unless they have heirs who are ill or incapacitated, people generally divide things equally among childrenyet in some cases it clearly might be fairer to leave more to a child who earns less or has a bigger family," says attorney David Schiller of Norristown, PA. "But people find it difficult to address such issues, so they simply ignore them. Maybe you shouldn't."
General guidelines. Let's say you've allowed flexibility, in a traditional way. You have a "sprinkling trust," in which trustees can adjust payments to various heirs as their needs changeeven unequally when appropriate (for example, if an heir requires medical care). The usual wording may not say anything about heirs' general behavior. But you might add something like "I want to encourage my heirs to lead productive lives, which may not be measured by money or results, but by sustained effort to live in a positive way. I would like my trustees to disburse money beyond the reasonable minimum only to heirs who are leading such lives."
Side letters. Suppose you do want to cover some specific situations, like stopping payments to an underachieving beneficiary. "Explaining that in the trust will likely require too many provisions," says Shenkman, "and may needlessly invite conflict." Instead, Shenkman recommends that the trust's wording permit flexibility in distributions, but without any specifics. "Then write a 'side letter' for the trustees, explaining what you mean and the guidelines you recommend. That way, they can follow your intentions, even though you've avoided making your words part of a formal document."
Disinheriting. Sometimes wills include provisions that cut children off out of angerif, say, the child is addicted to drugs. Parents may feel that the shock of being disinherited is the only way to influence their kids' behavior. "That's another situation in which incentive trusts can present a more effective approach," notes Chicago attorney Scott McCue. "If you provide, on an indefinite ongoing basis, for payments that will stop if heirs fail a drug test, you're at least providing a reason for them to improve."
Brad Burg. Will your heirs hate you for trying to do good?.