Could An Incentive Trust Help Your Child Find Their Way?

Kiplinger's recent coverage of the Great Wealth Transfer describes an estimated $124 trillion passing from older generations to heirs and charities through 2048. For parents, that inheritance tsunami raises a personal question: What will this money do to my children?

Sometimes an adult child hasn't found their way. Jobs come and go. Parents repeatedly pay the bills. Retirement savings never seem to get started. You want to help, but you worry that an inheritance — or simply the expectation of one — could make financial independence less urgent.

An incentive trust is one possible response. It ties distributions to specified actions or achievements, such as earning income, completing education or saving money. The appeal is understandable: Your assets could encourage the habits you hope your children will develop.

The difficulty is deciding what to reward, whether the reward will work and what happens when life departs from the plan.

Start with the behavior you want to encourage

"Be responsible" is a reasonable parental wish. It is a poor instruction for a trustee.

Suppose your daughter earns a steady income but saves little. A trust could match qualifying savings up to an annual limit. That gives the trustee something concrete to verify and your daughter a choice about how much to participate.

There is research supporting the potential of matching incentives. In a randomized experiment involving roughly 14,000 H&R Block customers, researchers offered IRA contribution matches of zero, 20% or 50%. Participation rose from approximately 3% without a match to 8% and 14%, respectively.

That is encouraging, but it answers a limited question. These were immediate incentives to contribute to retirement accounts. The study did not establish that participants increased their total household savings rather than moving existing money. Nor did it test whether an inheritance promised decades later would produce the same response.

The practical lesson: Matching deserves consideration. Its success in an estate plan should not be assumed.

Make sure the formula rewards what you value

An earnings match sounds straightforward: Earn a dollar, receive a dollar.

But imagine two siblings. One works in a lucrative industry. The other teaches elementary school or leaves paid employment to raise children. An identical matching formula produces very different benefits.

Legal scholar Joshua Tate's review of incentive trusts identifies this problem, along with the difficulties posed by illness, disability and circumstances the parent never anticipated.

If your goal is productive engagement, salary alone may be an inadequate measure. Your plan might recognize education, caregiving or public service separately. A fixed benefit for raising a child is another possibility, provided the document defines who qualifies and when payment becomes due.

These choices express your values. They should be deliberate.

Consider when the inheritance will arrive

Your children could be in their 60s when they inherit. By then, much of their working and saving life will be behind them.

If you hope to influence decisions in their 30s and 40s, consider discussing the arrangement while you are alive. A secret incentive cannot guide earlier choices.

For example, a plan could supplement retirement income supported by assets a child accumulated independently. A more ambitious version could offer higher matching rates as those independent resources grow.

That is a design possibility, not a proven behavioral strategy. The document would need to distinguish qualifying resources from other inheritances, account for pensions and avoid rewarding withdrawals that merely move money between accounts.

The family would also need to understand how changes in your finances could affect the eventual benefit.

A modest savings match during your lifetime may offer a useful opportunity to observe how your child responds before committing to a lasting arrangement.

Money cannot do every job

Some children need help developing skills, confidence or judgment. A financial reward may not address the underlying difficulty.

Psychological research also cautions against assuming that rewards invariably strengthen motivation. A review of 128 experiments found that certain expected tangible rewards reduced people's subsequent voluntary engagement in activities.

These experiments were not studies of inheritances, and they do not establish that incentive trusts fail. They do suggest caution about turning every valued activity into a paid transaction.

A trust can also pay for financial education, career counseling or help developing a workable budget. Those provisions may complement an incentive — or serve your child better than one.

Find an attorney who can work through the details

Incentive trusts require individualized drafting, and some estate planning attorneys may have little experience with them. Ask whether your attorney has drafted one and how they would address the practical difficulties.

Before signing, work through realistic examples. What happens after a layoff? During cancer treatment? When a child becomes a caregiver? Who verifies savings, and how much financial information must the beneficiary disclose?

For married couples, a QTIP marital trust may provide another safeguard. It can support the surviving spouse while preserving the remaining assets for children under incentive provisions fixed at the first spouse's death.

As long as the trust is properly drafted, the survivor cannot simply rewrite those conditions under family pressure. The children's payments from those assets would begin after the survivor's death, and the plan must preserve adequate support for the survivor.

The work begins with understanding your child's circumstances and translating your objectives into instructions a trustee can actually apply. Clear definitions, workable verification requirements and flexibility for unexpected events deserve as much attention as the incentive itself. The arrangement also needs to fit the assets available to fund it.

The question to bring to your attorney is specific: "What support would help this child build a more independent life, and how can we provide it without creating another obstacle?"

Related Content

• Why an 'Equal' Inheritance for All the Kids Doesn't Always Work: 4 Scenarios to Consider
• Is Your Will Actually Fair? Why Estate Planning Isn't Just About the Math
• What Would You Like to Leave Behind? A Financial Planner's Guide to Family Wealth Discussions
• Are You One of the Many Retirees Who Hoard Their Savings? Here's How to Stop Underspending
• Sitting on Large Capital Gains? This Trust Offers a Way Out, But Few Advisers Even Mention It

This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.