Q: My partner and I have three children and are looking for guidance on how to best plan to leave a legacy for them when we’re gone that will encourage them to continue their education and charitable work.
Is it possible to still maintain some control of our assets when we’re gone?
A: It sounds like you would like to know how far you can go in using your estate to provide rewards for actions and behaviors you would like to see carried out by your heirs. If that’s the case, you will probably find yourself limited more by your imagination and ability to foresee circumstances than by legal constraints.
Incentive Trusts: Keeping a steady hand on the tiller
A good legacy may work wonders for those left behind, but you may feel that your heirs need more than just financial benefit from your estate. If you would like to provide direction to your heirs and help ensure they pursue important life goals, you may consider including incentive trusts in your estate plans.
Where you can focus your legacy Following are some themes commonly contained in incentive trusts.
Education: Incentive trusts have been used to provide extra support to heirs who pursue advanced degrees, focus on designated fields of study or attend specified institutions. Some trusts are designed to reward outstanding scholarship and academic achievement. Some permit withholding support from those who fail to meet minimum levels of accomplishment.
Moral and family values: Within our LGBT community, some trusts are intended to promote family life by providing income support to heirs who choose to stay at home with children. Some offer bonuses for childbearing, foster care or adoption. Some withhold benefits from those heirs who might be convicted of a crime or fail a prescribed drug or alcohol-screening test.
Business and vocational choices: Entrepreneurs can use trusts to provide incentives to heirs who help carry on a family business. Trusts can be designed to encourage or discourage career choices specified by the trust creator. Trusts can also be used to offer focused financial support to beneficiaries who opt to follow paths that are personally and socially rewarding, yet generally less lucrative.
Charitable and religious opportunities: Many LGBT parents and their children participate in some form of organized religion. Some trusts are designed to encourage religious behavior by requiring specific observances. Some trusts provide funds for dues or other costs associated with religious participation. Some subsidize heirs who choose missionary work or other religious vocations. Some provide matching funds for heirs’ contributions to favored organizations.
Structuring an incentive trust
Incentive trusts can provide many of the same benefits as other types of trusts. For example, by placing assets in a properly designed trust, you can move them out of your estate in order to manage tax liabilities more efficiently. You can also ensure that assets will be managed professionally and held securely through a stable financial institution.
In addition, there are a number of considerations for trust design that may be especially significant for incentive trusts:
Goal-setting: The goals you wish to achieve with your incentives can be judged only by the terms you specify in your trust documents. Therefore, the most effective incentive trusts spell out concrete goals and offer objective, verifiable criteria for assessing their achievement. For example, if you provide incentives for educational achievement, you will want to indicate a threshold grade-point average rather than just saying “good grades.” You will also want to spell out the precise reward for achieving each goal.
Trustee selection: Interpretation and enforcement of your trust terms typically will fall into the hands of your designated trustee. Well-designed trusts not only name a trustee, but also list alternates and/or include provisions for naming a new trustee if the primary trustee becomes unavailable or incapacitated. Since a trustee’s decisions should be completely objective, be sure to designate a person that has no stake in the outcome of any trust provision. Also, be sure that the trustee is not a potential beneficiary of the trust.
Treatment of beneficiaries: Many trust creators try to be sure that all potential beneficiaries have equal opportunities to earn rewards from the trust. For instance, a beneficiary who excels at a vocation such as teaching, music or the arts should be rewarded just as someone who becomes a physician or an executive or chooses some other generally more lucrative career. Likewise, it is common that incentive trusts also have special provisions to provide assistance for beneficiaries with special needs.
Flexibility: Unforeseen events may interfere with carrying out the intentions of the trust in the future. Your beneficiaries may face illness, catastrophe or economic hardships that interfere with their ability to comply with trust terms. Therefore, you may want to lay out conditions under which your trustee can deviate from your blueprint in order to adapt when necessary.
Limitations to keep in mind
Incentive trusts may be subject to what is called the rule of perpetuities, a legal concept that says trusts must be liquidated at some point after their creation. This rule is enforced in many, but not all, states. It applies to trusts that are created in the state where the rule is enforced (you may generally create a trust in any state, not just the state in which you reside). As a consequence, you will want to be sure that any trust you do create can last for as long as needed to achieve your goals.
Certain types of incentive trusts may also be subject to the generation-skipping transfer (GST) tax. Where an incentive trust fits the complex definition of a GST, the rules limit the aggregate amounts that can be placed in the trust without incurring a tax of about half of the value in the trust. In some instances, life insurance can augment the amounts permitted under GST rules.
An incentive trust can be a powerful tool to help you provide continuing guidance and direction to your heirs. Yet creating such a trust involves complex legal, tax and investment-management choices. For this reason, be sure to seek advice from trusted legal and financial professionals.
Jeremy Gussick is a financial advisor with LPL Financial, the nation’s largest independent broker-dealer.* Jeremy specializes in the financial-planning needs of the LGBT community and was recently named a 2012 FIVE STAR Wealth Manager by Philadelphia Magazine.** He is active with several LGBT organizations in the Philadelphia region, including the Delaware Valley Legacy Fund, the Greater Philadelphia Professional Network and the Independence Business Alliance. OutMoney appears monthly. If you have a question for Jeremy, you can contact him at [email protected]. LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.
*As reported by Financial Planning magazine, 1996-2012, based on total revenues. **Award details can be found at www.fivestarprofessional.com .
This article was prepared with the assistance of S&P Capital IQ Financial Communications and is not intended to provide specific investment advice or recommendations for any individual. Consult your financial advisor, or Jeremy, if you have any questions.
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