By Steven J. Oshins, Esq., AEP (Distinguished)

Many attorneys draft incentive clauses into trusts. An incentive clause generally makes additional distributions to the beneficiary upon reaching certain milestones.

Probably the most popular incentive clause is one which makes mandatory distributions based on matching the beneficiary’s salary. That sounds great until you actually think through a real-life example and the disastrous results.

A REAL-LIFE EXAMPLE

Assume that Client has three young children. Child A grows up to be a top surgeon earning $3 million per year. Child B becomes a stay-at-home parent to three wonderful children and is one of the nicest people you could ever meet. Child C becomes an executive at a technology company and is earning $500,000 per year, but with a strained marriage that is headed for divorce.

CHILD A

“Child A grows up to be a top surgeon earning $3 million per year.”

Child A is constantly worried about malpractice lawsuits. It comes with the territory when you’re a surgeon since no matter how perfect you are there will always be clients who file lawsuits.

The last thing Child A wants is to receive an additional $3 million in forced distributions from a trust that otherwise could have been drafted as a creditor-protected trust. Child A doesn’t need or want the money. Not to mention, Child A will likely have an estate tax, so every dollar that is forced into Child A’s hands will cause a larger estate tax at Child A’s death.

Thus, the incentive clause in the trust fails miserably here.

CHILD B

“Child B becomes a stay-at-home parent to three wonderful children and is one of the nicest people you could ever meet.”

Child B is such a nice person, but unfortunately doesn’t have a lot of money. With three children to raise and a spouse who has a regular-paying job, even $100,000 in annual trust distributions would be life-changing and would give Child B the ability to send the children to private school.

Thus, the incentive clause in the trust fails miserably here.

CHILD C

“Child C becomes an executive at a technology company and is earning $500,000 per year, but with a strained marriage that is headed for divorce.”

Child C is doing great financially. A matching $500,000 probably isn’t needed, but would certainly make life easier.

However, the problem here is that Child C will be going through a divorce. One of the marital assets will be the vested right to a matching distribution every year in the amount of $500,000 (or whatever other dollar amount Child C is paid at work). This means that the divorce award will be a whole lot worse because the spouse will be divorcing someone who receives $1 million per year rather than $500,000 per year.

Had the trust been drafted as a fully discretionary trust, Child C could have received all, part or none of it in the discretion of the distribution trustee with Client C as the investment trustee and the undistributed trust assets would have been protected from divorce.

Thus, the incentive clause in the trust fails miserably here.

SUMMARY

In all three situations in the example above, the incentive clause failed. There are limited situations where an incentive clause can work well, generally where the client knows that this particular beneficiary is lazy and would be motivated to get a job if there was an additional incentive. But in most situations an incentive clause sounds good, but fails in actual practice and therefore should be used sparingly.

RELATED EDUCATION

If you found this article interesting, you might also be interested in these other educational programs and products by Steve Oshins:

• The Spousal Lifetime Access Trust: A Gifting and Creditor Protection Technique
• Estate Planning Techniques in a Time of Low Interest Rates
• The Installment Sale to an Intentionally Defective Grantor Trust
• The Grantor Retained Annuity Trust: Significant Estate Tax Savings with Nearly Zero Gift Tax Risk
• Steve’s FREE State Rankings Charts

ABOUT THE AUTHOR

Steven J. Oshins, Esq., AEP (Distinguished)  is a member of the Law Offices of Oshins & Associates, LLC in Las Vegas, Nevada. He was inducted into the NAEPC Estate Planning Hall of Fame® in 2011.  He has been named one of the 24 “Elite Estate Planning Attorneys” and the “Top Estate Planning Attorney of 2018” by The Wealth Advisor and one of the Top 100 Attorneys in Worth. He is listed in The Best Lawyers in America® which also named him Las Vegas Trusts and Estates/Tax Law Lawyer of the Year in 2012, 2015, 2016, 2018, 2020 and 2022.  He can be reached at 702-341-6000, ext. 2, at soshins@oshins.com or at his firm’s website, www.oshins.com.