Making Heirs Work for Their Wealth

Businessman Marty Holmes is convinced that paying his own way through college helped make him a success.

When his stepfather went bankrupt, Holmes got a job to cover his tuition at Georgia College & State University. Instead of partying, he began studying.

“When I started paying, my grade-point average doubled,” said Holmes, who is independently wealthy after selling his insurance agency last year.

Holmes believes his children, age 13, 8 and 5, also will appreciate education more if they help pay for it, even if he’s not around to supervise. So his estate plan includes a “family incentive trust” that would reward good grades, offer extra payments for graduate school and provide some, but not all, of his children’s college tuition expenses to ensure they contribute to the cost.

Dismissed as an expensive and potentially ruinous fad by some legal experts, family incentive trusts have nonetheless captured the imagination of newly wealthy parents concerned about leaving too much money outright to their children.

Interest in the trusts has increased in the last few years as stock market and real estate booms have created hundreds of thousands of new millionaires, said John Jeffrey Scroggin, the Holmes’ attorney and a leading advocate of family incentive trusts.

“I think the issues have been there all along. We just didn’t have so many wealthy people thinking about them,” Scroggin said.

Trusts that come with strings are not new--in fact, trusts by their very definition are designed to restrict the flow of inherited money to beneficiaries. For decades, concerned parents and other trust creators have designed vehicles that would apportion wealth over time, typically requiring the inheritor to reach some age milestone--21, 30, 35 or even later--before receiving distributions.

More rarely, trusts have included other requirements, such as that the inheritor be married or practice the same religion as the trust creator, before money was released.

Family incentive trusts, however, are adding much more elaborate riffs on this theme.

Affluent parents who want to encourage their children to work for a living may create trusts that match earned income dollar-for-dollar or link payouts to the beneficiaries’ own efforts to increase their net worth. Parents who want to produce entrepreneurs can turn the trusts into seed-money generators, matching any cash the beneficiary raises from other sources.

Good grades, thrifty habits, sober living and even the birth of grandchildren can be encouraged with monetary awards, whereas those who fail to toe the family line could find themselves without funds.

Financial advisor Joe Saul-Sehy said one of his clients decided to promote sensible money management among her adult children by requiring them to pay off any credit card debt before they can receive trust fund distributions.

Saul-Sehy, who works for American Express Financial Advisors in Auburn Hills, Mich., acknowledges that the stipulation could be an easy one to get around. The trustee supervising the distribution would have to run credit reports on the children to determine their financial status. Even then the heirs could disguise their credit card debts by taking out a home equity loan to pay off the balances.

“Trying to rule from beyond the grave is futile. There is always a way to get around these incentives,” Saul-Sehy said. Still, he said, the value of the trust is that it communicates to the children what the client wanted and valued, whether they ultimately choose to abide by the wishes or not.

The difficulty of enforcing many provisions of family incentive trusts is just one reason some legal experts--and advocates for beneficiaries--cast a skeptical eye on the documents.

Bob Whitman, an estate planning attorney and full-time law professor at the University of Connecticut, believes many people do not understand the expense and difficulties of administering a trust. He criticizes his peers for promoting “designer” versions that clients may not need.

“It’s like Seventh Avenue designer gowns--down the runway comes the next fashion, and look at that, it’s strapless,” scoffed Whitman, who also serves on a national board of professors that advocates trust and estate law reform. “It’s being put out there and people are blindly going for it.”

Like other critics, Whitman says the trusts are no substitute for good parenting. After-death provisions that restrict payouts to adult children are redundant if the parents adequately conveyed their values during life, and superfluous if they didn’t, he says.

“Think about the message you send to your children when you put money in trust,” Whitman said. “You’re taking away the responsibility of learning to use money, including making some mistakes.”

That sentiment is echoed by Standish Smith, founder of the advocacy group Heirs Inc. and husband to a woman who inherited money in a trust.

Smith, 68, says he has no problem with trusts that restrict payouts based on age, since most young adults are poorly equipped to handle large sums of cash.

But Smith believes elaborate trust provisions that reward only certain behaviors reflect the trust creator’s egoism rather than true concern for the child.

“It’s like, ‘My dad’s gone and I have to constantly prove myself to him still,’ ” Smith said. “Please, get out of my life.”

Attorney Scroggin disagrees that the documents are Draconian or unnecessary. He believes that creating the trusts forces clients to focus on how their wealth will affect future generations and enables them to put reasonable constraints on how the wealth is passed.

“It’s not that people want to disinherit or deprive their children. They want a middle ground,” Scroggin said. “The reality is, too much money too early destroys character.”

Attorneys and financial planners who specialize in these trusts say their clients already have strong ideas about how they want their money to be passed. The provisions are as unique as the “settlors”--an estate planning term for the people creating the trusts.

Scroggin’s clients include a Mormon family who rewarded children who went on missions, a Jewish client who encouraged working on a kibbutz in Israel and a philanthropically minded family that created its own “Nobel Prize” to reward beneficiaries most involved in religious or service work.

“The first priority is not to protect and preserve the money, it’s to protect and preserve the family,” Scroggin said.

Trust advocates agree that families can run into trouble if they design trusts that lack flexibility. What if a college education in the future can be achieved with the implantation of a computer chip, for example? That would render obsolete provisions providing for tuition, books and fees.

Many attorneys also include provisions that allow trustees to tap the funds, regardless of the incentives, if the money is needed for beneficiaries’ medical care or other emergencies.

Advisors say the trusts seem to be particularly popular among the first-generation wealthy--those who inherited little or no wealth from their own parents and who generally come from middle-class or lower-middle-class backgrounds.

James F. Schlager, a Bellevue, Wash., financial planner who counsels many Microsoft Corp. millionaires, said his clients want the trusts as a way to reward gainful employment and prevent distributions to children who are abusing drugs or alcohol or living a “beach bum” lifestyle.

“A lot of these people are the equivalent of blue-collar workers working in the technology field. . . . They’re all concerned that this money will ruin their kids,” Schlager said.

That description fits Holmes and his wife, Liza, who was one of nine children in a blue-collar family. Both are uneasy with the idea that, should they die prematurely, their children could live for years on their wealth without going to school or getting jobs.

“We never anticipated inheriting anything, but we never anticipated being this well off this young, either,” Holmes said.

The couple sees their family incentive trust as an extension of their parenting. Holmes said they look for ways to impart middle-class values of thrift and hard work--which is sometimes a challenge in their affluent Atlanta-area suburb of Alpharetta, Ga.

Though the local high school parking lot is filled with student-driven BMWs and Porsches, for example, the Holmes’ children won’t be presented with a new car on their 16th birthdays. Instead, the Holmes offer their children matching funds of up to $10,000 to help them buy the cars they want.

The family also promotes philanthropy, rather than consumption, by doing volunteer work together and makes joint donations to charities that promote education and target hunger, Holmes said.

In addition to rewarding education, the Holmes’ trust would make periodic payments until the youngest child reaches age 35, when the remainder would be donated to charity.

“We see a lot of children who are spoiled,” Holmes said. “We could create trust-fund children, and that’s not what we wanted.”

Not all parents who create family incentive trusts are uncomfortable with inherited wealth. Detroit auto executive Bernie Bedard, 54, bought his first home with a small inheritance from his mother.

Like many affluent parents, Bedard wants to help his children, age 17 and 20, avoid some of life’s harder knocks. Bedard himself worked his way up from the factory floor, attending night school to get his degree.

“It was too hard. I wouldn’t suggest it to anybody,” Bedard said.

The Bedard family trust would pay for the children’s college and graduate school if Bedard and his wife, April, should die within the next few years. Each child would get a bonus of $20,000 after getting a bachelor’s degree and $30,000 for getting a graduate degree. Subsequent distributions would be made until all the money is paid out by the time the youngest child is 40.

If the Bedards should die late in life, the children would receive the money outright. Bedard believes the children’s money habits would be well-established by middle age.

“Forty is a good age,” Bedard said. “I don’t want them to have large sums of money coming to them when they’re too young, because they’re less responsible. That’s the way I was, anyway.”

Those who have inherited large sums of money are far less likely to put restrictions on the wealth they pass to their children, said Myra Salzer, a Boulder, Colo., financial planner who specializes in clients who have inherited significant wealth.

“They feel like, ‘It was passed to me, so why should I put strings on it?’ ” said Salzer, who founded Wealth Conservancy Inc. and who holds workshops for inheritors.

But Salzer believes that even those born to wealth can benefit from properly structured family incentive trusts.

“The biggest problem a lot of the wealthy face is a lack of purpose, a reason for getting up in the morning,” Salzer said. “By creating incentives for their children, they can teach them to create their own purpose in life.”

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Times staff writer Liz Pulliam Weston can be reached at liz.pulliam@latimes.com.