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When an incentive trust can work

Incentive trusts can prove controversial for a few reasons. If you're considering one, it's important to consider how and when it may work -- and when it will not.

An overview

First off, let's define what an incentive trust does. You can pick incentives for your heirs. You put money into the trust. When they hit those incentives, they get their inheritance. For instance, you could say that your heirs need to complete a college education before getting your money, ensuring that they actually go to school.

You can also use it to prohibit some behavior, such as drug use. For example, you may say that your heirs get $12,000 every year until the trust gets depleted, but an arrest on drug charges ends the payments. They know that they have to keep out of legal trouble if they want that money to keep coming in.

When it does not work

The complaint about these trusts is that they usually do not work in the extremes. They could prove less than useful.

Take an heir who has a drug addiction, for example. Is telling them that they don't get their yearly payout going to convince them to break the addiction? Maybe, but probably not. Addiction is a medical condition. They need to work with professionals and seek proper care. Just the financial threat from the trust may do very little.

On the other extreme, take an heir who is extremely self-motivated. Is giving them an incentive to start their own business going to change whether or not they do it? Again, probably not. The money can help them, certainly, but they may have used it for the business no matter how you left it to them. Even if it was just an envelope of cash, they would have put it to good use.

The middle ground

When these trusts can work, then, is with people in the middle ground. An heir may consider dropping out of college but decide to stay for the last two years because they want to open up that trust. Or they may consider trying illegal drugs and then opt not to do it on the grounds that, should they get arrested the first time they use, it could have a massive financial impact.

Used properly, the incentive trust can guide them. But you also have to understand who your heirs are, what characteristics they have and what other influences play into who they become.

Setting up a trust

If you want to use an incentive trust or any other type of trust, it is important to understand all of the steps you need to take to get it set up properly.

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