What is an 'Incentive Trust'

An incentive trust is a legally binding fiduciary relationship in which the trustee holds and manages the assets contributed to the trust by the grantor. In an incentive trust arrangement, the trustee must adhere to specific requirements set out by the grantor regarding what conditions the trust's beneficiaries must meet in order to receive funds from the trust.

BREAKING DOWN 'Incentive Trust'

An incentive trust operates as a conditional inheritance for beneficiaries named in the trust. For example, an investor may wish to leave a certain portion of their estate to a grandchild, but also seeks to ensure that the inheritance does not reduce the grandchild's drive to pursue a professional career or a higher education. By leaving the inheritance funds to the grandchild in an incentive trust, the grantor can specify that the funds are to be dispersed only once the grandchild has obtained an undergraduate degree, for example, or any other legally permissible requirements the grantor may wish to specify.

What is an incentive trust grantor

The grantor is the person who creates the trust, and the beneficiaries those identified in the trust to receive the assets. The grantor may also be referred to as the settlor, trustmaker or trustor. The assets in the trust are supplied by the grantor. The associated property and funds are transitioned into the ownership of the trust. The grantor may function as the trustee, allowing them to manage the property in the trust, but it is not required. If the grantor is the trustee, the trust is referred to as a grantor trust. Non-grantor trusts are still funded by the grantor, but control of the assets are relinquished, allowing the trust to function as a separate tax entity from the grantor.

Grantor trust rules allow grantors to control the assets and investments in a trust. The income it generates is taxed to the grantor at their tax rate rather than to the trust itself. In this regard, grantor trust rules offer individuals a certain degree of tax protection because tax rates are generally more favorable to individuals than they are to trusts. Grantors can change the beneficiaries of a trust along with the investments and assets within it. They can direct a trustee to make alterations as well. Grantors can also undo the trust whenever they please as long as they are deemed mentally competent at the time the decision is made. This distinction makes a grantor trust a type of revocable living trust. However, the grantor is also free to relinquish control of the trust making it an irrevocable trust. In this case, the trust itself will pay taxes on the income it generates and the it would require its own tax identification number (TIN).

 
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