Many of us like to think that our children and grandchildren will be responsible enough to handle a large inheritance, if we can afford to give it to them. But the reality is that many children and young adults are not quite ready for the pressures and responsibilities that come with inheriting wealth. There is a way for you to use wealth as a positive motivator, monetarily rewarding younger generations for their achievements - it's known informally as an incentive trust. When used in a careful, sensitive manner, this type of trust can be an effective tool for promoting success within your family and reinforcing the values that matter to you. Here we look at the pros and cons of the incentive trust and some key considerations to keep in mind if you choose to establish one. (Learn the basics of this estate planning tool in Pick The Perfect Trust.)

What Is the Incentive Trust?
The incentive trust is a legal entity that holds and manages assets for the grantor or for the benefit of another person. It is typically established by a senior family member to provide innovative strategies for distributing wealth to younger generations; the grantor can use the incentive trust's provisions to reward a beneficiary for achieving a wide range of desired behaviors or goals. The trust can also set out specific requirements on how the money can be distributed and use certain techniques to ensure that the beneficiary will have financial independence beyond the inheritance monies.

As with any type of trust, there are costs associated with the development and ongoing administration of an incentive trust. The costs and the time involved in establishing this trust are just two factors you'll need to consider when deciding whether or not this arrangement is right for you. Next, you'll need to mull over some of the unique advantages and drawbacks of the incentive trust.

The Pros
Motivating Positive Behavior - An incentive trust allows you to reward the beneficiary for desired behaviors, while limiting access for undesirable behavior such as unproductive or immoral activity (of course, defining what is "immoral" can be quite subjective). Many trusts can be as restrictive as the grantor wants them to be, as long as the restrictions imposed are not illegal - for example, specifying that the beneficiary must divorce his/her current spouse to receive an inheritance.

Age Restrictions - Restrictions related to the beneficiary's age are often attached to trusts. You may not want your child to receive income or principal from the trust until he or she reaches a more mature age, such as 25, 30 or whatever you decide. You can also plan for distributions of funds to be staggered over time, at various "benchmark" ages, to help your child learn how to manage money responsibly. At the very least, this strategy eliminates the possibility of your child blowing his or her inheritance all at once.

Encouraging Education - Trust distributions can be contingent on the beneficiary graduating from high school, achieving certain grade point averages or obtaining a postsecondary degree. You could also decide to distribute a portion of funds after successful semesters or academic years as a positive motivating tool.

Promoting a Healthy Lifestyle - Some grantors will establish trusts that won't pay out money if the beneficiary indulges in destructive and/or illegal behavior such as smoking, using illegal drugs or abusing alcohol.

Family Business or Employment - Your incentive trust can include provisions that reward your beneficiary for assuming important responsibilities in a family business or simply maintaining gainful employment. As another way to promote employment, you can set up the incentive trust to pay out a matching amount for each dollar earned by the beneficiary. These are strategies that often appeal to wealthy parents, who may worry that their children lack a work ethic because they have grown up with money.

Endorsing Philanthropy - You can help your child develop an appreciation for volunteerism and community involvement by using matching charitable donations and other benefits that reward your child for teaching, doing community service and other charitable habits.

The Cons
Possible Resentment - You know the saying "The road to hell is paved with good intentions"? Despite your best intentions, your beneficiary may find that some of the requirements set out in the incentive trust (say, getting a college degree) are unattainable for him or her, and this may lead to resentment toward you as the grantor, or toward other beneficiaries who have met certain requirements contained in the trust.

Hindering Entrepreneurship - Using the incentive trust to encourage specific professional goals or to push your child into the family business may hinder your child's ability to pursue his or her own professional interests, such as starting a successful landscaping business or going into some other trade that you may have overlooked.

Setting Unrealistic Goals - Keep the goals and milestones realistic: some kids are not meant to run the family business or are not cut out for an Ivy-league school and a stellar academic career. Grantors should be sensitive to the unique personalities of beneficiaries and set goals that are attainable for all.

Overlooking Other Needs - Placing too much emphasis on business and academic achievements can lead to other matters, such as the health and overall personal well-being of the beneficiary, being overlooked.

"Controlling Life from the Grave" - The incentive trust may fail to work as the positive motivating tool you'd like it to be if the beneficiary feels that you are trying to control his or her life "from the grave", or to introduce values that should have been taught when the beneficiary was growing up.

Key Considerations
If you decide to establish an incentive trust for your heirs, you should use great care when drafting the necessary documents; make sure they allow a degree of flexibility to accommodate changing circumstances and unintended effects. For example, you should make sure that the trust provisions don't punish beneficiaries who choose to be stay-at-home parents or those who pursue lower-income professions. As a safety net, the trust should provide the beneficiary with the ability to support a family, even if he or she fails to achieve some of the goals set out in the trust. Of course, the provisions of the trust must also comply with federal and state requirements.

The key to the success of the incentive trust is good communication: make sure you discuss the intentions and restrictions of the trust with the trustee (the person or organization managing the trust) and the intended beneficiary. The trustee must understand your intentions clearly in order to enforce the provisions effectively, while the beneficiary needs to be aware of your wishes before you die so that he or she recognizes the trust distributions as rewards rather than bribes. (Selecting a trustee is an important step in estate planning. Find out more in Can You Trust Your Trustee?)

As the creator of the incentive trust, you need to choose your trustee wisely and seek the counsel of trusted advisors to help you develop the most appropriate plan based on your family's values. When used in a controlling, insensitive way, an incentive trust can backfire, producing results that are the exact opposite of what you intended. When used properly, however, the incentive trust can encourage higher education, philanthropy, a strong work ethic, healthy living and sound financial planning, and prevent the misuse of wealth. That way, you can pass on something more valuable than money to your family's younger generations - you can pass on valuable life lessons. (Don't know where to start? Check out our Estate Planning Basics Tutorial.)

For further reading on trusts, see Establishing A Revocable Living Trust, Shifting Life Insurance Ownership and Getting Started On Your Estate Plan.

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