By Alexander A. Bove, Jr.
and Melissa Langa
BridgeTower Media Newswires
It is a rare estate these days that doesn’t exceed a million dollars, and of course many are several times that. That’s good news for the beneficiaries — or is it? Will the sudden addition of a cool million to Johnny’s or Joanne’s bank account persuade either or both of them that they don’t really need that degree or that better job?
But wait — their parents were thoughtful enough to have established trusts for each of them so that the money would not be just handed to Johnny and Joanne outright. And good thing, because as it turned out the parents left about $6 million to those trusts after taxes.
As is typical in such cases, the trusts provide that income and principal will be paid to the beneficiary at the discretion of the trustee to satisfy the “needs” of the beneficiary. Assuming a 5 percent return on the $3 million trust for each, the annual income would be around $150,000, which could leave about $125,000 for distribution to the children after fees and expenses.
With that kind of money available to satisfy their “needs,” and that’s without touching the principal, it wouldn’t surprise anyone if Johnny’s or Joanne’s attitude toward their future needs relaxed a little. In other words, eliminating the need to work for a living and discouraging the children’s motivation to work hard and pursue a career is probably not what the parents had in mind.
Warren Buffet reportedly once said, “The perfect amount to leave one’s children is enough money so that they would feel they could do anything but not so much that they could do nothing.”
Sounds wise and impressive at first, but when you think about it, it doesn’t really address the issues. It completely fails to consider, for example, an immature beneficiary’s tendency to spend first and ask questions later (when the money is gone).
So, what are the options? There are several, but because there are so many movables, none of them is perfect.
For example, one possibility is to have the trustee pay to the beneficiary an amount equal to what the beneficiary earns from gainful employment.
Sounds good. But what if the trust isn’t huge and the beneficiary earns more than the trust income and gradually empties the trust?
And what if the beneficiary has a job and is simply happy to double her salary (with the trust incentive payment), so there is no need to work harder?
And how about the beneficiary who would like to change careers but doesn’t want to lose the incentive payment? And what if the beneficiary is or becomes unable to work due to disability or other circumstances beyond her control? (Can you spell “virus”?) Of course, the trust could include provisions for this, but it can get somewhat complicated.
Other “incentives” could include providing a bonus for the beneficiary if she earns a bachelor’s degree, or a master’s or doctorate. Presumably, in such cases, related living, travel and other expenses would accompany the effort, even if the degree were not awarded. Or would they? And what if the beneficiary decided to seek a degree at the Sorbonne in Paris? Or Sapienza University in Rome? Same deal?
Many such twists in the circumstances and application of the conditions will hinge upon the trustee’s determination as to what were the settlors’ (the parents in our example) intentions in imposing the conditions. In many cases, the trustee and the beneficiary may not see eye to eye, because there are so many variables.
The more difficult incentives to monitor and implement are the “moral” incentives, such as adhering to a certain religion, or having a productive career, or refraining from alcohol, or perhaps the most elusive and abstract — leading a good life. This group of incentives generally leads to trust disputes and needless expenses, since the goals are so abstract and subjective.
In our opinion, the best approach to an incentive trust is first to select a suitable trustee (and successor, or a means of appointing one) and provide the trustee with wide discretion.
Depending on the size of the trust, it might be a good idea to pair a family member trustee with a professional trustee, with the professional having the distribution power, as guided by the family member trustee who has a personal relationship with the beneficiary.
But that’s not all. The parents (or other settlors) should prepare a carefully thought out non-binding letter of wishes to guide the trustee in exercising its discretion. We wrote about the letter of wishes in our November 2018 column regarding trustee discretion, but it is also a wonderful alternative to the hard-to-enforce incentive trust.
The letter should clearly state the settlors’ wishes with respect to how liberal or strict they want the trustee to be in making distributions and what behaviors they want the trustee to encourage. And they shouldn’t hesitate to give examples of what they have in mind and what they would do in certain situations.
Whether liberal or strict, it is essential to note that one doesn’t preclude the other, just as it is common for parents to exercise both standards in the process of advising a child.
Preparing such a letter of wishes is not an easy task and may well be the hardest part of the plan, but it will be an enlightening exercise in thinking it through and writing it down. And count on going through more than one version of it. For those who might have trouble even beginning the letter, many estate planning law firms have samples — not to copy, because the thoughts and expressions must be the client’s — but to provide an idea of the form it takes and to offer a number of prompts to help the client get started.
The contents of such a letter will provide the trustee with some important and critical insight into what the settlors had in mind in supporting the child’s activities, career, ambitions, family, and his or her life in general, and an idea of how the settlors might have evaluated and decided in any given situation. No amount of trust drafting can replace that.
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Alexander A. Bove Jr. and Melissa Langa are shareholders at Bove & Langa in Boston, where they concentrate in domestic and international trust and estate law.
