Incentive Trusts vs. Discretionary Trusts
Trusts are flexible legal instruments that can be drafted to accomplish a diverse array of estate planning goals. One of the areas of flexibility concerns how much freedom the trust Grantor gives to the Trustee in terms of making distributions. Trusts can be broadly categorized into “discretionary trusts” and “incentive trusts.”
Incentive Trusts
In an incentive trust, the Trustee has guidelines and limits for distributions based on the class, status, and/or behavior of beneficiaries. These guidelines and limits are drafted to give effect to the Grantor’s intent for the handling of trust property. In practice, distributions are often made contingent on the beneficiary’s completion of certain conditions; hence the beneficiary has an incentive to do what the Grantor wanted them to do. The basic message to the beneficiary is, “If you do X, Y, and Z, then you will get more money from the trust.”
Common Incentives
Some of the most common incentive provisions in trust documents include:
Education
- Attainment of college degree
- Matriculation at a particular school
- Achievement of a particular grade point average
Behavior
- Marriage or re-marriage
- Procreation
- Place of residence
Gainful employment
- Work in a particular field
- Work in the family business
- Start a new business
- Matching of income reported on a W-2
Negative behaviors
- Drug and alcohol abuse
- Gambling
- Crime
A basic example of how an incentive provision in a trust might look is, “Mary will receive $1000 per month from the trust until she is thirty-five years old. When and if Mary earns a bachelor’s degree, the Trustee shall make a one-time $25,000 distribution to Mary from the trust. If Mary earns her degree from Whitman College, then said one-time distribution shall be $50,000.”
Discretionary Trusts
In a discretionary trust, the Trustee may exercise his or her discretion in making distributions. In a “fully discretionary trust” the Trustee has a high degree of freedom in deciding how best to handle the trust property, and the timing and amount of distributions to beneficiaries. This is the most common type of trust, because it is the most flexible and it is the least costly to draft. The disadvantage to putting so much discretion in the hands of the Trustee, however, is that the behavior of the beneficiaries may not be influenced according to the Grantor’s wishes.
The more complex a trust is, the more important it is that it be drafted correctly by an experienced attorney.