‘Incentives’ Can Save Beneficiaries from Themselves
Written by Bogutz and Gordon
What to leave children, grandchildren, or other beneficiaries can be a difficult decision for anyone — especially if potential beneficiaries are not responsible with money or you are concerned a bequest will eliminate the need for hard work and productive contributions to society. A discretionary trust with incentive provisions is a possible solution.
For all the legalese you see in a Trust document, at its heart it is a set of instructions on what the Trustee is supposed to do with certain property in certain stituations. A discretionary trust gives the Trustee the ability to decide to make–or not to make–distributions to the beneficiaries, based on whatever standards or guidelines that the creator of the Trust (known as the Settlor) writes into the document. The Trustee’s discretion allows them to make judgment calls.
Sometimes, a Trust will let a beneficiary be his or her own Trustee because the Trustee’s decision making is not at issue, and instead the Settlor is concerned about protection from other parties. However, a Trust of this kind can alternatively provide that someone else is the Trustee. The Trustee could be another family member, a family friend, a bank, a professional licensed fiduciary, or a bank that acts as a corporate Trustee. Frequently, for younger beneficiaries, someone else is named as Trustee until a certain age, and then the beneficiary becomes his or her own Trustee.
The Trust document spells out how the Trustee is to spend the money for the beneficiary. The Trustee may be given varying degrees of discretion to decide whether spending is appropriate. If the Trustee has total discretion, the beneficiary has no right to demand a distribution. Since the beneficiary has only an expectancy interest in the Trust, he or she cannot use the Trust as security for a loan or to satisfy creditors.
Some examples of the levels of discretion:
- None: “The Trustee shall make distributions for health insurance premiums not paid for by an employer and insurance copays for necessary medical procedures and medication.” In this case, the Trustee must pay.
- Some: “The Trustee may make distributions for health insurance premiums, medical procedures or medications, taking into consideration all resources available to the beneficiary.” In this case, the Trustee can pay but he or she must assess whether there are other funds available.
- Total: “The Trustee, in his or her total and unfettered discretion, may make distributions for the general health and well-being of the beneficiary.” The Trustee then could purchase anything that contributes to good health – gym membership, vitamins, running shoes, relaxing vacation – or decline to distribute anything.
In addition to the general discretionary granted to the Trustee, the settlor can give the Trustee the power to specifically promote a productive lifestyle by cutting off distributions if a beneficiary becomes involved in destructive behavior, such as drugs, alcohol, excessive spending, or gambling. The money could simply be saved until the beneficiary’s behavior turns around, or the Trust could provide additional beneficiaries. A Trustee also could be given the option to make payments directly for the benefit of a beneficiary, to, for instance, a rehab facility or hospital, but not to the beneficiary.
A Trust also could specify that a distribution not be made to a beneficiary who is not striving to become a productive member of society by working, making reasonable progress in attaining an education or launching a career or business. Without provisions such as this, a Trustee may be at a loss to determine whether to pay for rent, food, and clothing for a healthy 30-year-old who simply chooses not to work.
There are some legal limitations to restrictions; they cannot be unreasonable or against public policy. A Trust could not, for instance, prohibit distributions if a beneficiary gets married or act as an incentive to divorce because public policy favors marriage.
Things to consider:
- Does the Trustee have enough flexibility to respond to changing circumstances? If you limit distributions to health and education, but your beneficiary is short on cash for a car repair, do you really want the Trustee to be unable to help?
- Is the Trustee power so flexible that the beneficiary has little or no ability to challenge a Trustee’s actions? If you give the Trustee absolute discretion, it may be difficult to challenge the Trustee’s decisions, and the Trust could be vulnerable to abuse. You could name several Trustees as a check and balance, have a Trustee committee, or appoint a Trust Protector to intervene in the event of a dispute.
- Do the terms create interpretation or enforcement difficulties? If you prohibit a “hedonistic” or “indolent” lifestyle, would your named Trustee have the ability – or desire – to make such a judgment? (“Hedonism,” by the way, is defined in Merriam-Webster as “the doctrine that pleasure or happiness is the sole or chief good in life,” and indolent as “habitually lazy.”) Would you expect the Trustee to investigate a beneficiary to determine what kind of lifestyle he or she is living? If your Trustee is a family member or close family friend, will he or she want to make that call? Would a bank or other institution? A prohibition against distributions to a beneficiary using drugs sounds simple on paper, but how does the Trustee need to prove this? Consider consulting with your prospective Trustees regarding the terms and whether they will accept the trusteeship with your desired terms.
- Do the terms create a complicated administration and potentially high fees? A lot of requirements, such as considering a beneficiary’s other resources or lifestyle choices, can create additional work for the Trustee, which may be reflected in the fee that the Trustee charges.