Powers of Appointment: Situations Where You Might Use Them
By: Barry E. Haimo, Esq.
April 10, 2024
A Power of Appointment is a very powerful tool that you can include in a trust to provide additional flexibility if you don’t want to stay locked into the original terms forever. What is it exactly? How does it work?
Below, we’re going to define Powers of Appointment, discuss some ways to limit them, and then look at some situations where you might want to use them.
What’s a Power of Appointment and How Does It Work?
Read Transcript
Hi. Welcome back to another dose of Bite-Sized Bits of Knowledge, where we give you meaningful information in a short amount of time. Today, we’re going to talk about a really important provision of trusts that has relevance to wills. It’s called a Power of Appointment.
So the big picture here is that the Power of Appointment is a provision that goes into a trust. There’s usually, I would say, two main kinds of Powers of Appointment. And what it’s doing is it’s allowing other people to exercise a power, typically to designate a different beneficiary than would otherwise be the case in the trust.
In the case of what’s called a general Power of Appointment, a person that you give the power to would have the ability to designate pretty much anybody or any entity to inherit the trust proceed – the balance of the trust upon that beneficiary’s death. That would include the beneficiary themselves, the beneficiary’s estate, the beneficiary’s creditors, and creditors of the beneficiary’s estate. It could mean their neighbor, their spouse, their partner, their friend. It’s pretty broad when it comes to a general Power of Appointment. In contrast, a Limited Power of Appointment is where you’re limiting the power that the beneficiary has to designate other people or entities to take over that beneficial interest.
So, generally, a Limited Power Appointment would be limited to anybody – any recipient – except those four things I just mentioned, which would be the beneficiary, the beneficiary’s estate, the beneficiary’s creditors, and creditors of the beneficiary’s estate. So a Limited Power is typically like any other recipient except those four things. So that’s also broad.
It’s very common then, as you might expect, to give that power, but even further limit it. Say, for example, to only family members or only certain amounts. You can do a lot of planning with these powers. They predominantly derive for tax – estate tax planning purposes. It’s utilized, I think, as more of a flexibility thing for the trusts, but it’s important to understand what they are and how they can be used.
In terms of how you use them, the beneficiary has to be aware of them. They have to be able to exercise them. The way to exercise them is typically in their will. The beneficiary says, in their will, “I hereby exercise my power of appointment in Section 123 of Trust ABC, and hereby designate such and such person in such and such amounts to receive my beneficial interest.” And that’s how that would be exercised.
So it’s not for everybody. It’s not always used, but it’s something that I think is important to understand. Certainly, if you have one already, it’s in a trust for you, or if you’re planning and you’re trying to create some flexibility because you just don’t know what’s going to happen in the world and your family, your beneficiaries, deep into the future, you can build in some flexibility now. So I hope you found this helpful. Thanks for stopping by and stay tuned for more.
Now that you understand Powers of Appointment with a bit more clarity and the difference between regular and Limited Powers, let’s look at anothe big way to limit a Power of Appointment.
Lifetime Versus Testamentary Powers of Appointment
A Power of Appointment can be characterized as either a Lifetime Power of Appointment or a Testamentary Power of Appointment, depending on when it can be exercised by the power holder. For instance, if the power holder can distribute property among grandchildren only while alive, this is a Lifetime Power of Appointment. If it’s also restricted in scope, it would be a Lifetime Limited Power of Appointment. Similarly, a power to distribute property freely during the power holder’s lifetime is a Lifetime General Power of Appointment.
Conversely, if the power can only be exercised upon the power holder’s death, it is a Testamentary Power of Appointment. This power is typically executed through a provision in the power holder’s will or trust, detailing the distribution of the property upon their death. Therefore, a person may hold a Testamentary Limited Power of Appointment, a Lifetime Limited Power of Appointment, a Testamentary General Power of Appointment, or a Lifetime General Power of Appointment.
Reasons You Might Want to Set Up a Power of Appointment
Powers of appointment can serve various purposes in an estate plan, such as providing tax benefits, protecting assets, and ensuring flexibility.
Here are some examples that highlight their potential uses:
Flexibility
A mother creates a trust to benefit her only son during his lifetime, with the remainder passing to her grandchildren upon his death. However, she is concerned because three of those grandchildren have issues like drug use and poor financial habits.
To address this, the mother grants her son a Testamentary Limited Power of Appointment. This means that he can decide how to distribute the trust property among his children based on their future behavior and needs. This arrangement gives the mother some control over her estate while providing her son with the flexibility to adjust the distribution according to changing family circumstances.
Tax Savings
A particular trust contains corporate stock that is rapidly appreciating. The creator’s daughter is designated to receive the dividends, while the daughter’s children are the remainder beneficiaries. The daughter holds a Testamentary General Power of Appointment over the trust. Upon her death, this power ensures a full step-up in tax basis for the stock, eliminating capital gains taxes for her children when they sell the stock. This results in significant tax savings.
Family Harmony
A woman has children from a previous marriage. She wants to provide for her second husband, but ultimately leave her wealth to her children. To ensure the second husband is treated well by her children after her death, she includes a Testamentary Limited Power of Appointment in her estate plan. This power allows the second husband to decide how to distribute certain company stock among her children. By giving the second husband some control over her children’s inheritance, the woman hopes to encourage her children to treat him respectfully.
These examples demonstrate the versatility of Powers of Appointment in enhancing estate planning. However, they can also introduce risks. For instance, if the second husband in that last example were to act vindictively, he might allocate the entire inheritance to one irresponsible child, resulting in unintended consequences.
With Great… Powers of Appointment Comes Great Responsibility
Understanding the uses and limitations of Powers of Appointment can help you identify when they might be beneficial in your estate plan. Review your own estate planning documents and those of your loved ones to see if these powers are appropriate for your situation.
If you need more information on how Powers of Appointment can help you achieve your estate planning goals while maintaining flexibility, reach out. We’re always happy to talk about your needs.
Author:
Barry E. Haimo, Esq.
Haimo Law
Strategic Planning With Purpose®
Email: barry@haimolaw.com
YouTube: http://www.youtube.com/user/haimolawtv
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