Columns M ONEY & SOUL

Not Your Typical Incentive Trust: The ROTE and FST, Part 1

by Eileen Gallo, Ph.D.; Jon J. Gallo, J.D.; and James Grubman, Ph.D.

Eileen Gallo, Ph.D., is a Planning of the University of Miami seeks to encourage receive money and psychotherapist in private School of Law. Instead of Eileen writing possibly trusteeships. Behavior that practice in Los Angeles, her typical Money & Soul column and the trust creator seeks to discourage is California, where she Jon writing his Tax & Estate column, we punished through the withholding of works with individuals decided we would jointly co-author both trust distributions and trusteeships. and families dealing with columns with James Grubman, Ph.D., At fi rst glance, the inclusion of issues related to money. and share our concepts with the readers incentive provisions in irrevocable Along with her husband, of the Journal. This column lays out the trusts seems a reasonable approach. Jon Gallo, she is the problem, and the Tax & Estate column Why not motivate members of the co-author of two books on children and money and off ers our solution. next generation to engage in behavior co-founder of the Gallo Institute. Their websites are Most estate planners and fi nancial the trust creator approves of and to www.galloinstitute.org and www.fi parent.com. advisers have listened to clients express- discourage behavior the trust creator ing concern about the possible negative wishes them to avoid? After all, people Jon J. Gallo, J.D., chairs eff ects their money the Family Wealth Prac- has or will have tice Group of Greenberg on their children. Glusker Fields Claman Most of us hear such Machtinger & Kinsella comments as, “My It turns out that the behaviors LLP in Los Angeles, child doesn’t have the on“ which incentive trusts typically California. slightest idea of the value of a dollar,” “She focus are not reliable predictors of will blow through responsible money management. James Grubman, Ph.D., of her inheritance in ” Family Wealth Consulting, fi ve years,” and, “If I is a psychologist and leave my money to consultant to families of my son, he’ll never do wealth and the advisers anything with his life.” typically work for a living with their who serve them. Because of these reservations, one income contingent upon the satisfac- His website is www. approach adopted by many estate plan- tory completion of that work. Doesn’t jamesgrubman.com. ners and fi nancial advisers is to suggest the business world pay for perfor- that their clients consider the use of mance? Aren’t incentive estate plans an incentive trust. An incentive trust merely a refl ection of real life? n January, the three of us introduced attempts to infl uence benefi ciary behav- Despite the widely held belief that the concept of the Results-Oriented ior through the inclusion of carrot/stick money makes the world go round, a ITrust Environment (ROTE) and the provisions related to trust distributions review of the estate planning literature, Financial Skills Trust (FST) at the 45th and trusteeships. Benefi ciaries who as well as major studies in motivational Annual Heckerling Institute on Estate engage in behavior that the trust creator psychology over the last 40 years and

32 JOURNAL OF FINANCIAL PLANNING | April 2011 www.FPAnet.org/Journal M ONEY & SOUL Columns

anecdotal evidence, identify four major incentive distributions. and challenging, we are less incentiv- drawbacks to the use of incentive trusts: 3. It appears that many typical incen- ized. How do you turn an interesting 1. Money is an eff ective incentive tive provisions—particularly those and challenging activity into work? You only if the behavior that is being relating to education and income attach money to it! incentivized is routine and boring, matching—have little correlation A fascinating study to this eff ect was such as working on an assembly with the ultimate goal of an incen- undertaken by the Federal Reserve line repeatedly engaging in the tive trust: that the benefi ciaries Bank of Boston in 2005. The Fed same procedure hour after hour. It become responsible money manag- underwrote a study by four economists is not an eff ective incentive if the ers. It turns out that the behaviors who traveled to a village in India and behavior that is being incentivized on which incentive trusts typically off ered participants enough money that involves cognitive skills (memory, focus are not reliable predictors of it could materially alter their lifestyle. judgment, and reasoning). responsible money management. There were 87 participants divided into That leaves us with a paradox, Both the estate planner who drafts three groups. Each group had to accom- demonstrated in more than 100 the trust and the settlor who signs plish nine goals, six involving cognitive studies conducted in the last 40 it most likely assume that such skills and three involving routine years by institutions ranging from behaviors as graduating from col- activities. Group 1 could earn one day’s the London School of Economics lege and being employed full time pay for achieving the goals. Group and the University of Chicago are evidence the benefi ciary has 2 could earn two weeks’ pay. Group to the Federal Reserve Bank attained a desired level of fi nancial 3 could earn six months of income. of Boston. Using money as an maturity and responsibility so that There was no discernible diff erence at incentive is typically not eff ective disastrous fi nancial outcomes are all between Groups 1 and 2. Group 3 to develop the very skills incen- unlikely. As most of us know from did worse in eight of the nine activities, tive trusts seek to encourage in our practices, the fact that someone including every one of the activities benefi ciaries, such as work ethic, has substantial earned income or a involving reasoning, judgment, and responsible money management, college education is not in the least cognitive skills! and empathy for others leading predictive of whether this person On the most basic level, what do to involvement in philanthropy. lives within his or her means, parents typically want for their chil- In fact, money incentives actually makes sensible investments, or dren? Based on our work with fami lies decrease performance involving avoids abusing credit. and estate planners over many years, such cognitive skills as judgment 4. Finally, the estate planning we believe that most parents want their and reasoning by converting what literature is fi lled with articles children to exhibit what psychologists would otherwise be viewed as pointing out that incentive trusts call a strong sense of self-effi cacy. an interesting and challenging tend to be infl exible and diffi cult to Self-effi cacy is the belief in one’s abil ity activity into routine work! administer. to succeed in life. It is a can-do attitude. 2. In the business world, there are As advisers, few of us encounter well-documented studies in which Money as a Disincentive parents who want incentive trusts when using money as an incentive has Why does money reinforce simple work their children already possess a can-do led to unethical and sometimes tasks but often backfi re for complex attitude and strong sense of self-effi cacy. illegal behavior by the employees cognitively challenging tasks like money Clients who are inter ested in incentive being incentivized. Although management? The answer lies in a 1908 trusts are almost exclusively parents unethic al behavior by benefi ciaries study that produced what is known as who complain about their children’s of incentive trusts does not appear the Yerkes-Dodson Law. If we view an lack of self-motivation and self-effi cacy. to be well documented in the activity as interesting and challenging, These children typically have a cor- estate planning literature, there is we want to do it. (This is sometimes responding expectation (or need) to be anecdotal evidence that incentive referred to as the “Tom Sawyer Law” supported fi nancially by their parents. trusts have inspired some benefi - in honor of Tom getting his friends to As a demonstration of this, we ciaries to game the system and whitewash the fence that he was sup- encourage you to engage in a brief present the trustee with fraudu- posed to do by convincing them it was thought experiment. Make a list of those lent evidence of income or school fun.) Vice versa, if we view an activity as clients who have expressed an interest attendance in order to qualify for work rather than something interesting in the use of incentive trusts. Draw a www.FPAnet.org/Journal April 2011 | JOURNAL OF FINANCIAL PLANNING 33 Columns M ONEY & SOUL

vertical line down the center of a piece grant the trustee the discretion to pro- member of society by making meaning- of paper. Label the left side “strong vide benefi ts if the child is physically or ful and positive contributions to family, self-effi cacy” and the right side “poor mentally disabled. Some of these plans community, and society,” and handling self-effi cacy.” Using the roster of clients provide partial or complete forfeitures “money intelligently and avoiding from the fi rst step, list those clients if the child does not meet minimum wasteful spending.” whose children exhibit a strong sense of standards. For example, current income The increased fl exibility of the self-effi cacy in the left column and poor not distributable to the child might Handler and Lothes approach and its sense of self-effi cacy in the right col- instead be distributed to charity. Other focus on behavioral benchmarks is a umn. Compare the number of families plans provide for termination of the welcome contribution to the literature in each. Typi cally, when estate attorneys child’s trust and distribution of principal of incentive trusts. However, we believe or fi nancial advisers are asked to engage to charity if three to fi ve consecutive that some of the benchmarks are so in this experiment, the left column is years elapse during which the child fails subjective that both the trustee and blank or nearly so. What we take from to meet the minimum requirements for the benefi ciaries lack guidance as to this is that, often, clients are asking us income or principal distributions. how the benchmark is to be met. For to create a trust, which, in the words of The listing approach requires detailed example, the trustee is to consider an anonymous attorney, “makes up for specifi cation of activities and behaviors. whether the benefi ciary is “avoiding lessons that were not learned as a child.” Recommended reading for those wasteful spending.” The application interested in fi nding out more about of this criterion appears to be entirely Approaches to Incentive Trusts the listing approach to incentive trusts dependent on the trustee’s value system There are three basic approaches to include Nancy Henderson’s Managing and not on the settlor’s values. Is a ben- drafting incentive trusts: Carrot and Stick Provisions: Selected efi ciary engaged in “wasteful spending” Absolute Discretion. In this Fiduciary Issues in Drafting and Adminis- if he purchases a 60-inch TV but not the approach, settlors select a trustee who tering Trusts with Incentive Provisions; an 42-inch version? Moreover, many of the is perceived as sharing their values, and ALI-ABA Course of Study, Representing behaviors the trustee is asked to take they provide the trustee with absolute Estate and Trust Benefi ciaries and into consideration are not necessarily discretion in making distributions of Fiduciaries (2008); and Joshua Tate’s indicators of the benefi ciary’s ability income and/or principal to the benefi - “Conditional Love: Incentive Trusts and to manage money responsibly. Being a ciaries of the trust. In such a situation, the Infl exibility Problem”1 (concluding college graduate does not guarantee that the trustee’s discretion is generally that incentive trusts pose an infl exibility one is neither a miser nor a spendthrift. tested using a good faith standard. problem because the settlor cannot The Listing Approach. In this foresee all potential eventualities and Results-Oriented Philosophy approach, behaviors that are incentiv- take them into account). We believe it is possible to create ized or discouraged, together with the Behavioral Benchmarking. In the behavioral benchmarks that are clear, carrots and sticks attributable to meet- article “The Case for Principle Trusts objective, and more highly correlated ing or failing to meet the designated and Against Incentive Trusts,”2 David with the benefi ciary’s ability to manage criteria, are set forth in varying degrees Handler and Alison Lothes argue against money responsibly. We believe this can of detail. Often the drafting attorney a rigid listing of behavioral benchmarks, be accomplished based on a recent inno- will use a restricted defi nition of ascer- such as graduation from college or full- vation in management practices known tainable standards—health, education, time employment, and in favor of using as a ROWE—Results-Oriented (or maintenance, and support—to prepare what they refer to as principle trusts. In Results-Only) Work Environment. The the list. a principle trust, the trustee is provided ROWE was invented by Cali Ressler and The two most common forms of with guidance embodied in a list of Jody Thompson, executives who worked productive behavior encouraged are what the article describes as positive within the human resources department graduation from college and full-time behaviors the client wishes to encour- of BestBuy. They subsequently formed employment. Benefi ciaries who accom- age. The article provides examples of their own company and wrote Why Work plish these goals often earn the right to various behaviors that might be on the Sucks and How to Fix It,3 in which they receive distributions at an earlier age. list, such as pursuing an education at describe the concept as follows: “In a Motherhood and caring for the home least through college, pursuing “gainful Results-Only Work Environment, people on a full-time basis are sometimes taken employment with a view toward being can do whatever they want, whenever into consideration. Virtually all plans self-suffi cient,” becoming “a productive they want, as long as the work gets

34 JOURNAL OF FINANCIAL PLANNING | April 2011 www.FPAnet.org/Journal M ONEY & SOUL Columns

done.” Because there are no fi xed hours drafting. If the primary goal of the happy, productive lives, most of the time but rather fi xed goals, employees in a typical incentive trust is to encourage and for most people, incentive trusts do ROWE are evaluated entirely on their responsible money management by the not produce that result. We do not view results. benefi ciary, the focus in a ROWE would the ROTE as an improved version of an The core principle of a ROWE is be on the goal—responsible money incentive trust; it is an alternative, and its that those who possess the fi nancial management—and not on the process use is discussed in detail in our compan- rewards (the managers of a company) by which the benefi ciary achieved that ion column in this issue. should focus on and reinforce the goals goal, especially highly unreliable and or results desired, not necessarily any indirectly connected activities such as predetermined structure, methodology, going to college or full-time employ- or pace of how the results are achieved. ment. It would be possible to identify In doing so, a ROWE encourages the behavioral benchmarks or component Endnotes development of necessary skills and skills that are not only objective but that 1. Tate, Joshua C. 2006. “Conditional Love: behaviors in employees as well as their correlate directly with the benefi ciary’s Incentive Trusts and the Infl exibility Problem.” autonomy and their growth. Those ability to manage money responsibly. Real Property, Probate, and Trust Journal 41. with good intrinsic motivation and With a bow to Ressler and Thompson, 2. Handler, David A., and Alison E. Lothes. 2008. self-effi cacy tend to rise to the challenge we therefore suggest the outcome “The Case for Principle Trusts and Against and perform well. Those who lack these would be the creation of a ROTE: a Incentive Trusts.” Trusts & Estates (October). important characteristics typically don’t Results-Oriented Trust Environment. 3. Ressler, Cali, and Jody Thompson. 2008. Why sustain their work performance and do Although incentive trusts may work for Work Sucks and How to Fix It: No Schedules, No not get rewarded. some benefi ciaries who need just that Meetings, No Joke—the Simple Change That Can Suppose that the underlying con- little extra push that an incentive trust Make Your Job Terrifi c. New York: Portfolio. cepts of a ROWE are applied to trust provides in order to get motivated to lead

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