Powers of Appointment and Estate Planning: What You Should Know

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(Newswire.net — October 13, 2022) — Estate planning is a neglected part of financial planning, despite the huge ramifications it has for families. One issue that deserves particular attention is the role and importance of powers of appointment in estate planning.

What are the Powers of Appointment?

Powers of appointment are the powers that a testator, or donor, who writes a will or trust, grants to a specific person to dispose of what is known as “appointive property”, in the will or under the terms of the trust. This designated person is known as a “power holder” or “donee”. Those who can be eligible to receive part or all of the appointive property are known as “permissible appointees”. There are two broad classes of powers of appointment: general powers of appointment and special powers of appointment.

A power holder’s role is only to distribute the property, whereas a trustee exists to manage the property. Indeed, the power holder does not own the appointive property.

There are tax and legal regulations which govern who can be granted powers of appointment, when those powers can be granted, and how broadly those powers may be defined. Where trusts define powers of appointment, there may be different kinds within a single will or trust.

In order to exercise powers of appointment, the power holder has to have a specific express clause in their will in which they exercise that power.

The appointive property may or may not fall under the estate of the power holder, depending on the terms of the powers of appointment. Powers of appointment may have gift tax implications, again depending on the terms. Furthermore, there may also be income tax implications. The complexities demand that you consult with a tad adviser when you are planning your estate or want to exercise any powers of appointment you have.

Normally, a third party grants powers of appointment, although it is technically possible to grant yourself powers of appointment. It is also possible to create an “incomplete gift trust”, that reserves limited powers of appointment.

Powers of appointment are very powerful estate planning tools that you need to learn more about.

General Powers of Appointment

The Internal Revenue Code §2041 defines general powers of appointment as those that allow the power holder to appoint to themselves, their estate, their creditors, or creditors of their estate the right to beneficial use and enjoyment of the property within this power. For example, you may specify in your will that, “I leave my art collection to be distributed by my wife as she sees fit”.

The holder of general powers of appointment is, under estate tax law, treated as if they own the property subject to that power, even if they do not exercise their power. In other words, that property falls under the estate of the power holder.

The Internal Revenue Code §2056(b)(5) holds that general powers of appointment fall under marital deduction tax law, if, in the event of the death of one spouse, the surviving spouse has a general power of appointment over the remaining trust property.

A power holder can point to the terms of a will that created that power and can decide on how to distribute the property. This can be done by creating a trust, such as a revocable living trust, which you can learn about here.

In the event that general powers of appointment are not exercised, then the default terms of the will come into effect.

Special Power of Appointment

A special power of appointment is conferred upon a person, the donee, who has to distribute the specified property among a specified group of individuals, barring the donee, and their estate, creditors, or estate’s creditors. For instance, in your will, you may grant someone special powers of appointment to distribute specified property among a specified group of people. The power holder can then choose who among the designated people will receive the designated property.

However, if the person with special powers of appointment does not exercise that power, the designated property reverts to members of the designated group, known as “default takers”.

There are two kinds of special powers of appointment: exclusive and nonexclusive. Exclusive special powers of appointment allow the donee to exclude one or more group members of those who can be appointed to receive the property, from receiving that property. Nonexclusive special powers of appointment prevent anyone from being excluded.

Special powers of appointment exist not just in wills but in trusts, as a means to limit generation-skipping transfer tax, or grant asset protection trust features while avoiding fraudulent conveyance liability. These trusts are known as SPA Trusts.

Why Should You Understand Powers of Appointment

If you have been granted powers of appointment in an irrevocable trust, you have the ability to distribute those assets, shifting their value as you see fit. In other words, you can essentially rewrite the terms of the trust.

This is vital in providing flexibility to you. Your desires may change over time, along with your goals, and you need to be able to adjust your estate as you see fit. Indeed, tax law has changed significantly in recent years, and that alone is a motivator for you to change your estate.

What Should You Do Now?

You need to conduct an inventory of all your powers of appointment. You can do this by going through every trust in which you are eligible to be a beneficiary or a power holder. As we implied above, powers of appointment are distinct from the rights of a beneficiary. You do not need to be a beneficiary to be a powerholder. Indeed, often, power holders do not typically have an interest of any kind in a trust document.

When you have gathered all these documents together, share them with your attorney, so they can conduct an audit and see what, if any powers of appointment you have.

In addition, you should create a file of the summary details of the trusts you are named in. This will help you in the future so that you don’t have to go through the same audit process in the future.

You should state, in the summary, on what page and section of the document your powers of appointment are named. This is especially important for very long, and very complex documents that are too long to go through quickly.