Immortal Coil
Those in estate-planning circles call Fontaine’s vehicle an incentive trust. Controversial because they seek to control beneficiaries’ lives from beyond the grave, incentive trusts lay out provisions that recipients must meet before receiving monetary distributions. Benefactors can design them to encourage anything from higher education and entrepreneurship to personal values such as charitable giving, employment or marriage among future generations. Grantors may also design them to discourage behaviors that they oppose, such as substance abuse or gambling, even obesity. Only imagination—and public policy—limit the options. (For example, a trust with incentives regarding marriage to someone of a certain race or faith would not likely hold up in court.)

TOP VIEW Incentive trusts contain provisions that beneficiaries must meet before they receive distributions. While some see them as attempts to control behavior from beyond the grave, they can be useful tools for communicating and instilling values, as long as they are well thought-out and flexible enough to stand the tests of time.

Those who want to pull strings from behind the veil of tears should do so with caution. If not properly designed, incentive trusts can unfairly reward certain beneficiaries and punish others in a way that the grantor never intended, thereby fueling inequities and family resentments. “You cannot create character through a bribe,” says Michael Kavoukjian, a Miami-based partner with the law firm White & Case. “Trying to micromanage descendants’ lives from the grave, no matter how well intentioned, can have unforeseen consequences.”

Fontaine’s trust is a good example. It overlooks eventualities such as the difference between a child who becomes an investment banker and another who becomes a missionary. The banker would receive large, taxable distributions he or she may not need, while the missionary—who clearly is engaged in a productive, meaningful life—will get very little from the trust, despite having greater need. An educational incentive, which is seemingly less problematic, also has drawbacks if, say, a beneficiary has a learning disability that keeps him or her from graduating from college.

Since incentive trusts are a fairly new estate planning concept, their long-term effect is unknown. They are unproven in a litigious sense because most, if not all, have not yet been implemented, says John Scroggin, an attorney and expert on incentive trusts with Scroggin & Co., a tax and estate planning firm in Roswell, Ga.

Because of their complexity, these vehicles are also more expensive to draft. Whereas the cost of a typical trust may range from $2,000 to $10,000, depending on the complexities involved, an incentive trust begins at the top end of that range and, depending on its scope, rises in cost from there.

Trust Fund Triumphs
Despite these issues, there is a growing interest in dictating lifestyle terms to heirs. In a survey of some of the wealthiest 1 percent of U.S. citizens by U.S. Trust in 2000, 61 percent worried that their children would place too much emphasis on material possessions, and 57 percent were concerned children would be naive about the value of money. Those concerns have also come to light in a host of subsequent surveys. “It used to be that asset preservation strategies were primary motivators and family issues were secondary. We have reversed those roles,” says Scroggin, who, along with colleague Robert Littell coined the term family incentive trust in the mid-1990s, after reading a magazine story in which Warren Buffett said the perfect inheritance is enough so beneficiaries feel they could do anything, but not so much that they could do nothing. Scroggin believes incentive trusts can provide an ideal solution, but only when drafted with enough flexibility to adapt over time. A sound incentive trust, attorneys advise, is one that is thought out thoroughly beforehand, is not overly controlling and does not give too much power to one individual (or to the trust document itself).

Backers believe incentive trusts can be excellent vehicles for communicating and teaching values to children. Myra Salzer, a financial advisor with the Wealth Conservancy in Boulder, Colo., who works primarily with adult inheritors, says, “There is often such a disconnect between inheritors and their money. [Incentive trusts] give inheritors more options, creating a cause-and-effect relationship with the money.” She advises clients to thoroughly examine their aims and expectations, and she has designed a three-page values questionnaire to assist in the effort. The exercise may seem tedious, but Salzer finds that it helps clients think through their motivations for creating such a trust, and helps them to better express these motivations to other family members, as well as to attorneys drafting the trust.

Salzer also advises grantors to be up-front about their expectations with their heirs—particularly their direct descendants—before and during the trust-drafting process. “The issues are not always cut and dry, and there will be beneficiaries who feel it is not fair,” she says. But if they are involved, they will not be surprised by the terms of the trust later on. 

Elastic Intent
Attorneys say that attaching clear and concise trustee guidelines to a normal trust is an excellent, nonbinding alternative to an incentive trust (in which all of the provisions are etched in legal stone). “It’s more effective to create a trust that gives the trustee complete discretion, and attach a separate letter of intention that describes what the grantor would like to see happen and not happen in terms of use of the trust,” says Gail Cohen, executive vice president and general trust council with Fiduciary Trust International in New York. To encourage gainful employment, for example, the letter would direct the trustee to make very liberal distributions up to and above the child’s salary, and to be very strict in making distributions to a child who is not gainfully employed. “It’s similar terminology, but it’s not binding,” Cohen explains. While incentive trusts have not yet been tested in court, she predicts this nonbinding approach is less likely to face lawsuits from angry heirs. “The trusts that see the most litigation in general are those that have not been flexible enough to change with the times,” Cohen explains.

“TRYING TO micromanage descendants’ lives from the grave, no matter how well intentioned, can often have unforeseen consequences.”

Another way to add flexibility to an incentive trust—or any trust designed to benefit multiple generations—is to include a limited power of appointment that gives each generation some ability to amend the trust, says Domingo Such, a partner in the Chicago office in the law firm of McDermott Will & Emory. This tactic gives beneficiaries the ability to adjust, for their own heirs, any of the original grantor’s instructions that may become outdated, for example, a disparity of disbursements between men and women. Limited power of appointment gives today’s beneficiaries the power to change or remove trustees for the benefit of future beneficiaries and to appoint successor trustees who share and understand the original grantors’ values and judgments. These powers are limited in scope, and a beneficiary cannot use them to change his own distributions.

For grantors who are uncomfortable handing such delicate discretion over to one corporate representative or family member, experts recommend using cotrustees: one corporate trustee and one family member. The corporate trustee will administer the trust coolly and impartially, relying on college transcripts, W-2 forms, drug tests or other objective factors to determine distributions; the family cotrustee can take more of a subjective perspective, taking into account the strengths, weaknesses and individual personalities of beneficiaries who may not be meeting their incentives.

“Our family trustee is our children’s grandfather, and he is more generous than conservative,” notes wealth advisor Rich Hogan with Hogan Barry Advisors, a division of Merrill Lynch Private Wealth Management in San Francisco, who has created his own incentive trust. The trust was designed to take into account many different scenarios, but in the case that there are factors he forgets to include, the family trustee has the discretion to make judgment calls. “He may give away too much, but he is prudent enough to know if the struggles in our kids’ lives are self-induced. He has the discretion to shut the whole thing down should a child show signs of doing drugs or walking away from our values.” 

Scroggin and other attorneys also recommend that individuals attach incentives to only a portion of an inheritance, rather than the entire estate. This option allows parents to encourage good behavior without seeming Draconian. Most of Ray Fontaine’s estate, for example, will go without restriction to his children, grandchildren or the family foundation. Meeting his incentives will provide a bonus for heirs. Fontaine insists, “The way I’ve structured the trust should not cause anyone to be upset.”

Illustration by Kevin Spaulding.