Tuesday, January 23, 2007

Incentive Trusts

Professor Joshua C. Tate of the Southern Methodist University, Dedman School of Law, has published an interesting paper on incentive trusts entitled "Conditional Love: Incentive Trusts and the Inflexibility Problem," in the Real Property, Probate and Trust Journal, Vol. 41, pp. 445-496, 2006.

I have read about incentive trusts, but as far as I know they are not frequently used in British Columbia. In a nutshell, you can set up a trust, either during your lifetime, or in your will, the terms of which make any payments out of the trust to your children or other beneficiaries conditional upon them reaching specified goals. In this way, you can create financial incentives for your beneficiaries to behave in certain ways. For example, you may encourage the accumulation of wealth, educational achievement, charitable giving and even procreation.

Professor Tate gives examples of number of specific provisions, my favourite being "$10,000 on the first marriage of each descendant of mine, provided that the new spouse has never gone to law school."

Imposing conditions on beneficiaries before they can receive gifts in wills or trusts is not new. But I am under the impression that marketing conditional gifts as "incentive trusts" is a relatively recent phenomenon.

Professor Tate discusses what I think is the main problem with "incentive trusts": they may not be flexible enough to adequately deal with the various contingencies life presents. He provides some good examples, such as the following at pages 464 and 465,

With regard to educational conditions, an obvious possibility is that a beneficiary might be unfit to attend college and may need more support for this reason. This could happen, for example, if the beneficiary suffers from a learning disability. Such a beneficiary might not be accepted into a college or might have great difficulty achieving the minimum GPA fixed by the trust. If the settlor sets the bar too high, even beneficiaries without learning disabilities may be unable to meet the conditions [footnotes omitted].

In his paper, Professor Tate discusses the problem of inflexibility in the context of varying laws governing trusts within the United States of America. In some states, it is difficult for the beneficiaries or trustees to vary a trust with conditions that may not be very practical in the circumstances. The problem of inflexibility may be exacerbated in those states that allow trusts to continue in perpetuity.

The problem of inflexibility may not be as great of a problem in British Columbia as in some of the United States. As I have written in other posts, in British Columbia, in some circumstances the beneficiaries can all agree to terminate a trust, and the Trusts and Settlement Variation Act, RSBC 1996, c. 463, permits the Supreme Court of British Columbia to consent to a variation or termination of a trust on behalf of beneficiaries who do not have the legal capacity to consent. Except in the case of a charitable trusts, you cannot set up a trust in perpetuity.

Still, the kinds of conditions imposed by the creators of incentive trusts can create some formidable practical problems if the world does not unfold as they intended.

I was not a big fan of incentive trusts before I read Professor Tate's paper, and I am more skeptical about their utility since reading this article. I approach this as a practicing lawyer, and also on a personal level. As a lawyer, I think that if you want do not want your children or other beneficiaries to have complete control of their inheritance, the better way to do it is through a more flexible trust in which you give your trustee discretion to make payments to the beneficiaries. You then choose a trustee whose judgment you trust, and perhaps who shares your values. There are many circumstances when I recommend using a discretionary trust instead of outright gifts, particularly for beneficiaries who may inherit while they are still young.

Personally, I think at some point we should let our children or other loved ones shape their own lives, and pursue their own dreams.

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