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Incentive Trusts: Ensuring That an Inheritance Will Be Well Spent
Patricia Bloom-McDonald • Mar 01, 2022

Many parents or grandparents with sizable amounts of money to pass on to their heirs are apprehensive about the effect it many have on their children or grandchildren. In some instances, they fear that the recipients will misspend the funds on drugs, fancy cars or failing businesses. In other cases, the fear is simply that their children will lose their drive to achieve and overcome barriers that may present themselves if there’s no financial necessity to do so.  

At the same time, these parents and grandparents want to provide a safety net to their heirs and enhance their lives in an increasingly insecure financial system. Often, they do so by leaving funds for their descendants in a trust that distributes the funds at certain ages – say, one-third at age 25, one-third at age 30 and the rest at age 35.  But some parents set up what are known as “incentive trusts,” which get very specific in their instructions to trustees to ensure that the trust funds support what the trust’s creators view as positive behavior and discourage unproductive activities.  Such trusts may pay the costs of certain activities, like a college education or advanced degree, or provide rewards for achieving various milestones.  Others may withhold distributions when the beneficiary engages in certain negative behaviors or activities, such as drug use or excessive spending.

Here are some ways incentive trusts might be structured:

  1. Rewards for degrees.  Cash amounts that descendants receive on achieving specified educational milestones.

  2. Matching earnings.  The trustee would be instructed to match on a dollar-for-dollar basis the child’s earnings from employment, or, if lavish spending is the concern, the child’s savings.

  3. Paying for education.  Especially with the high cost of private universities today, grandparents often set up funds to help pay for education. Some funds are more expansive than others in terms of what they will cover. Just undergraduate degrees, or also graduate programs? Only for higher education, or also for learning a craft or a trade? Will the fund pay for private school before college? Will it cover educational programs during the summer, including travel overseas? Room and board, or just tuition? Some of the answers will be determined by the size of the fund and how far it needs to stretch.

  4. Creating a charitable foundation or donor-advised fund.  To encourage charitable giving among descendants, an estate plan could require heirs to give away a certain amount every year to a private foundation or to a donor-advised fund.

  5. Subsidizing public service career or Peace Corps.  We live in an increasingly financially insecure world that often forces people to take or stick with careers they don’t find fulfilling or don’t feel further the public good. Parents or grandparents could fund trusts that don’t match all earnings, but just those they feel make the world a better place. This may be hard to define and will, of course, be different from fund to fund. It may include working for any not-for-profit — though some are quite well funded — or teaching or political organizing for certain causes.

  6. Distribution upon marriage or having a child.

  7. Matching the down payment for a house.

  8. Reward for a period of time being alcohol- or drug-free.

Through these incentive trusts, parents and grandparents hope that their money will go to causes they support. On the one hand, this approach can multiply the benefit of what they pass on. On the other, it may seem to some that the deceased is trying to continue to exercise control much too long after they are gone. Often the older generations split the difference, giving some funds outright to their descendants and leaving the rest in trust.

However, an incentive trust must be carefully constructed, both to ensure that its terms are clear and that it does not violate any constitutional or public policy law or standard. For example, in one case that ended up in the courts, grandparents set up a trust that withheld funds from any grandchildren who married outside the Jewish faith. Two Illinois courts ruled that the clause disinheriting the grandchildren was invalid because it was against public policy by placing a significant limitation on the grandchildren’s freedom to marry.

If you are interested in creating an incentive trust, contact our office for a no-cost initial consultation.

Using a Credit Card When You Have a Special Needs Trust

25 May, 2023
A special needs trust (SNT) allows you to meet your needs while receiving government benefits, such as Medicaid/MassHealth and Supplemental Security Income (SSI). When you have a special needs trust, you can use it to pay for goods and services government benefits do not cover, such as therapy, education,and housing. Since receiving income directly from your trust would jeopardize your eligibility for benefits, your trustee cannot give you cash from your SNT. When you use a credit card for permitted transactions, and your trustee pays off the balance with funds from your trust, these payments to a credit card company are not considered income. An SSI or Medicaid/MassHealth recipient who is capable of managing their own affairs can therefore use a credit card to make small purchases, and the trustee of the special needs trust need not micromanage every transaction. In the past, beneficiaries of SNTs sent their bills to their trustees for payment. Today, an individual with an SNT who qualifies for a personal credit card may find that using a credit card is more convenient. Credit cards have several benefits. Using a credit card to manage payments from your special needs trust allows you to maintain independence, gain access to some of the advantages of a credit card, and easily keep records while preserving your eligibility for Medicaid/MassHealth and SSI. Although credit cards can help people manage their special needs trusts, there are also several important restrictions and considerations to keep in mind. Consult with a special needs planner to ensure all transactions are acceptable under the trust's rules and comply with government regulations. The Benefits of Using Credit Cards When You Have a Special Needs Trust If you have a special needs trust, using a credit card has many benefits, including: Independence : Allowing you to maintain your independence. You can use your card to make qualifying purchases yourself. Your trustee does not have to make the transactions for you. Access to the Typical Advantages of a Credit Card : Using it responsibly can help you establish or build credit history, which may be important for your future financial needs. Record-Keeping : Credit cards provide easy record-keeping and a convenient way to monitor transactions from your special needs trust, which can also help special needs trustees fulfill their duty to maintain records. When you use your card, your trustee can observe your purchases and ensure that all expenses are allowable under the trust’s rules. Your statements can help your trustee keep track of funds leaving the trust. Benefits Eligibility : While adhering to Medicaid/MassHealth and SSI’s income and asset limits, you can access funds from your SNT. Credit cards can help prevent your trustee from accidentally providing you with cash payments that could affect your eligibility for government benefits. Considerations When Using a Credit Card for Your Special Needs Trust While you can use a credit card to access funds from your special needs trust for certain transactions , restrictions apply. If your trustee sees a charge on your card that could affect your benefits eligibility , they can flag it for review. You cannot use your credit card to pay for food and shelter, which SSI would cover. When administering your funds, your trustee must ensure that any expenditures are for your sole benefit if you have a first-party special needs trust. While using a credit card is appropriate, you should not use a debit card. Debit cards are considered cash income. Best Practices When using a credit card for a special needs trust fund, remember several best practices. Choose a card with low fees and interest rates. Set a clear budget and monitor transactions regularly. Keep thorough records and receipts of expenses. Consult with your special needs planning attorney. A special needs planning attorney can help you navigate the rules that apply to your trust and understand how to use a credit card to preserve your Medicaid/MassHealth and SSI eligibility. 

How an ILIT can help offset estate taxes

12 May, 2023
With the Federal estate tax exemption possibly about to be lowered, it may be time to think about steps you can take to keep your estate from being taxed. An irrevocable life insurance trust allows you to pass on money to your heirs while avoiding both the federal estate tax, as well as any applicable state estate tax which is currently $1 million in the Commonwealth of Massachusetts. Senate Democrats have proposed lowering the current estate tax exemption from $11.7 million for individuals and $23.4 million for couples to $3.5 million for individuals and $7 million for couples. While it is unclear if this proposal will pass, it is likely that some change to the estate tax is coming. Even if Congress does not take any action, the current rate will sunset in 2026 and essentially be cut in half, to about $6 million per individual. In the Commonwealth of Massachusetts, the current estate tax exemption is $1 million for individuals and is taxed at dollar $1.00. A proposal to raise it to $3 Million and the tax to start at $3 Million (not at $1.00) has been submitted in the legislature but has not yet been voted on or enacted. One way to make up for any estate tax your estate may have to pay is by setting up an irrevocable life insurance trust [ILIT]and funding it with a policy that has a death benefit that would pay your heirs some or all of the amount your estate will be taxed. If you purchased such a life insurance policy directly, it could end up being taxed as part of your estate. But if a trust owned the policy, it could pass outside your estate. While a life insurance trust can be highly beneficial, it is also complicated to set up and maintain properly. The following are some of the requirements: Trustee . If you are setting up the trust, you cannot also serve as a trustee. If you are the trustee, you have control of the trust, which could lead to the trust being included in your estate. You will need to name another trusted person or financial institution to act as trustee. Policy ownership . The trust must own the life insurance policy. If you transfer an existing policy to the trust and die within three years, the policy will still be considered a part of your estate. To avoid this risk, the trust can purchase a policy directly rather than receive an existing policy. Premiums . You need to transfer funds to the trust to pay the policy premiums, which creates an issue with gift taxes. A transfer to a trust is usually not subject to the $15,000 yearly gift tax exclusion. For a gift to qualify for the exclusion, the recipient must have a "present interest" in the money. Because a promise to give someone money later does not count as a present interest, most gifts to trusts aren't excluded from the gift tax. To avoid this, you can use something called a “Crummey” power which gives beneficiaries the right to withdraw the funds transferred to the trust for up to 30 days. As part of the process, the trustee needs to send them a letter, known as a Crummey letter, letting them know about the trust funding and their right to withdraw the funds. After the 30 days have passed, the trustee can use the funds to pay the annual insurance premium. You run the risk of the beneficiaries withdrawing the funds, but if they know that by allowing the money to stay in the trust they will receive more money later, it shouldn’t be a problem. Beneficiaries . The beneficiary of the life insurance policy is usually the trust. Once the funds are deposited in the trust, the trustee can distribute the assets to the beneficiaries in the way specified by the trust. For example, if your beneficiaries are minors, you can wait to have the trustee distribute the assets. Keeping the assets in the trust will also protect them from your beneficiaries’ creditors. The downside of an irrevocable life insurance trust is that you do not have the ability to change it once it is set up, although the policy would effectively be canceled if you stopped paying the premiums. If you are considering this type of trust, discuss it with your attorney.
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