An incentive trust is much like a traditional irrevocable trust, except that it sets specific conditions on trust distributions. Some people establish incentive trusts to make sure beneficiaries stay in the family business. Others want to encourage higher education or public service. Some want to discourage behavior, i.e., laziness, reckless spending, or drug use. Still others want to encourage beneficiaries to get married and raise a family.

Incentive trusts have advantages and disadvantages

If you think an incentive trust may be a useful part of your estate plan, consider the advantages and disadvantages.

The advantages of incentive trusts include:

• If you write the conditions for disbursement properly, they provide objective criteria for when and how to make these disbursements.

• They encourage beneficiaries to behave in ways that are important to you.

• They allow you to condition disbursement on your beneficiary's age, so you can decide when he/she is old enough to responsibly manage the inheritance.

• They can help you accomplish goals through your beneficiaries, such as continuing the family business or pursuing philanthropic interests.

But there are also disadvantages:

• While incentive trusts allow you to specify conditions for distributions, they restrict the ability of trustees to make different decisions if new circumstances arise.

• Incentive trusts can cause resentment among beneficiaries, who may feel it is not your place to tell them how to live their lives.

• Encouraging goals you think are important may cause beneficiaries to neglect other good opportunities. For example, you may want a beneficiary to start a business, but he/she may be better suited to another career choice.

• Incentive trusts may be plagued by the law of unintended consequences. How can you foresee the future long after you've died? You may instruct the trust to pay out a stipend for your beneficiaries to go to school, but that may encourage them to become "professional" students.

• Because incentive trusts are often more complicated than traditional irrevocable trusts, they may be more expensive to establish and maintain.

What to think about

There are a number of issues that could affect the design and implementation of an incentive trust. Consider these points carefully:

• Goals -- What behaviors do you want to promote? Incentive trusts are often created to encourage beneficiaries to pursue higher-education degrees. Discouraging reckless consumption and unproductive behavior are other common reasons behind incentive trusts. Think about what matters to you and your beneficiaries. What goals are fair and reasonable for you to expect your beneficiaries to achieve?

• Coordination with your estate plan -- Incentive trusts are just one component of an estate plan. Decide whether you want to create a separate incentive trust or build incentive clauses into a trust designed for another purpose. Make sure the incentive trust doesn't conflict with or detract from other components of your estate plan.

• Duration -- How long do you want the incentive trust to last? For grantors with substantial wealth, a trust may span many generations. Can you realistically set expectations for beneficiaries who aren't even born yet?

• Beneficiaries -- Who will benefit from the monies disbursed from the incentive trust? Considerations here are similar to those for any kind of trust: who do you include and exclude?

• Trustee designation -- The trustee of an incentive trust typically has a more difficult job than the trustee of a simple traditional trust, since he/she must decide when beneficiaries have met the conditions you specified. Make that job easier by writing conditions that are objective and easily measured.

How to prepare an incentive trust

If you decide an incentive trust may be right for you, you should:

• Sit down with your beneficiaries and trustee to discuss your goals for the incentive trust. The likelihood that your beneficiaries will later resent the incentives is greater without this discussion.

• Build flexibility into the trust to accommodate changes in circumstances. This will mitigate unintended and undesirable consequences.

• Ensure that the conditions you want to include comply with state and federal laws.

If you don't want to establish an incentive trust, you can limit each beneficiary's inheritance to an amount that isn't likely to encourage reckless consumption and unproductive behavior. Another alternative, if your interest lies in philanthropy, is to establish a private foundation and name your beneficiaries as board members. That way, your money is still controlled by your beneficiaries, but it is put to charitable use.