Some people shy away from creating trusts because putting assets into a trust means losing some control over that property. However, there are various techniques that can allow grantors (the trust’s creator) to have more flexibility over assets held in the trust. One of these techniques is using a power of appointment.
What Is a Power of Appointment?
In its most basic form, a power of appointment is the right to dispose of property held in a trust. The grantor of a trust creates the power when the trust is established and confers the power upon themselves or another person, such as a beneficiary. A power of appointment allows the grantor, or the person upon whom they confer the power of appointment, to change the disposition of property held in the trust at a later date.
What Are the Types of Powers of Appointment?
The grantor can confer one of two types of powers of appointment:
- General power of appointment: The power holder is allowed to distribute property in the trust to any person or entity, including distributing it to the power holder, the power holder’s creditors, the power holder’s estate, or creditors of the power holder’s estate.
- Special or Limited power of appointment: The power holder can direct property to be distributed to any person or entity EXCEPT for the power holder, the power holder’s creditors, the power holder’s estate, or creditors of the power holder’s estate. This power can also be further limited to a specific class of permissible recipients, for example, lineal descendants of the grantor.
The trust agreement will specify whether the power granted is a general or special power of appointment, and will usually specify how the power may be exercised, as well as what happens if the power holder does not exercise the power of appointment.
How Are Powers of Appointment Used in Estate Planning?
Powers of appointment allow grantors to customize their estate plans to meet their needs while they are alive and after death. They provide flexibility especially when using irrevocable trusts because they allow the grantors of the trust to change their minds and redirect distributions from the trust, or even change the remainder beneficiaries of the trust.
As an example, a husband and wife may create an irrevocable lifetime trust and place a majority of their property into said trust. The original trust may state that both of their children are equal remainder beneficiaries of the trust. However, the couple can alter these terms by granting themselves a power of appointment in the trust. Note, however, that the type of power, general or special, can impact whether the assets of the trust are considered part of the grantors’ estate (or the estate of any person holding a general power of appointment) for estate tax purposes. Years later, they could exercise their power of appointment and decide to name only one child as the remainder beneficiary, perhaps because that child’s needs far exceed those of the other child. The power of appointment allows the grantors to account for changing circumstances or family dynamics. Having a grantor retain certain powers of appointment over trust property may cause the transfer of assets to the trust to be deemed an “incomplete gift” under applicable tax laws, which may be advantageous in certain situations (e.g., when the grantor has already used their applicable exclusion from gift tax).
Importantly, powers of appointment can also be limited to only certain property held in a trust. For example, a trust may hold both real property and cash assets. The grantor can restrict the power by making it specific, rather than general, and have it only apply to the real property in the trust.
What Are the Tax Considerations of Using a Power of Appointment?
There are important tax considerations associated with powers of appointment that should be discussed with an attorney. Taxation varies depending on whether a general or specific power was conferred.
For a power holder who has a general power of appointment, the value of property subject to that power is typically included in the power holder’s gross estate and potentially subject to estate tax since the power holder retains the ability to redirect property to himself or herself. However, the value of property subject to a limited or special power of appointment is not typically included in the power holder’s estate. However, even limited or special powers of appointment can sometimes cause unintended inclusion of trust assets in the power holder’s estate, and thus present potential pitfalls for the unwary.
Do You Need an Attorney?
Estate planning is not just about planning for how you want your assets distributed upon death. There are opportunities to protect your assets and save money during your lifetime using tools like trusts. To learn whether a trust and power of appointment is the best option for you, contact us for a consultation.
