If you have built up a large estate and plan to share your wealth with your children, you may be concerned about their ability to handle a significant inheritance. You should be aware that there are steps you can take to help ensure that they won’t squander their inheritance soon after receiving it.
Build incentives and flexibility into a trust
An incentive trust is a trust that rewards children for doing things that they might not otherwise do. Such a trust can be an effective estate planning tool, but there’s a fine line between encouraging positive behavior and controlling your children’s life choices.
Incentives can be valuable if the trust is flexible enough to allow a child to chart his or her own course. A so-called “principle trust,” for example, gives the trustee discretion to make distributions based on certain guiding principles or values without limiting beneficiaries to narrowly defined goals.
For example, an incentive trust that bases distributions strictly upon the income earned by a child, will not take into account the fact that a child engaged in certain socially beneficial professions, such as teaching or social work, may not earn as much as a child who becomes a surgeon.
Consider distribution amounts and timing
Many parents take an all-or-nothing approach when it comes to the timing and amounts of distributions to their children, either transferring substantial amounts of wealth all at once or making gifts that are too small to provide meaningful lessons.
We suggest that you consider making distributions large enough so that their children will have something significant to lose, but not so large that their entire inheritance is at risk. For example, if your child’s trust is worth $2 million, consider having the trust distribute $200,000 when your son or daughter reaches age 21 and staged distributions after that. In this scenario, the distributions will be large enough to provide a meaningful test run of your child’s financial responsibility while safeguarding the inheritance over a time period thought to be reasonable by you.
Make your legacy last
If you plan on leaving a sizable amount of your estate to your children, consider incentive trusts or trusts providing for periodic distributions to your children of principal. Contact us to learn additional strategies to prepare your children for their inheritance.