Your family, the economy, the law, and society can change rapidly and unexpectedly, affecting your best-laid estate plans in unpredictable ways. To achieve your estate planning goals, you need a plan that can keep up with the changes. And few estate planning tools provide more flexibility than a general power of appointment.
You cannot see into the future. But appointing a trusted person to decide who will receive your money and property when you are not around to make that decision could be the next best thing.
The Power of a Power of Appointment
For as long as you are alive and mentally able, you can make estate plan adjustments in real time that reflect life’s inevitable changes.
Maybe you have a loved one who recently came into money and no longer needs as much of an inheritance as they once did, so you decide to change your will or trust and divert money to other beneficiaries. Or maybe a loved one suddenly takes on a large amount of debt, prompting you to put money for them in a trust rather than giving it to them in one lump sum in order to protect it from their creditors. Later, that same loved one pays off their debt, and you change their gift back to the lump sum inheritance. Alternatively, there might be a major tax law change that forces you to reconsider your gifting strategy from top to bottom.
These are some examples of circumstances that might cause you to make adjustments to an estate plan. A divorce or birth in the family, the success or failure of a family business, or an economic boom or bust might also prompt you to revisit your plan.
Ideally, you have been diligent about updating your estate plan every few years to ensure that your plan still reflects your wishes. But you may wonder whether you can plan for changes that occur after your death, both in the near and far term.
The short answer is yes, if you use a power of appointment in your will or trust.
How a Power of Appointment Works
An estate plan can either leave money and property to a beneficiary outright, or it can direct that the money and property be held in trust for a beneficiary with specific instructions as to when and how the beneficiary can access that inheritance. But a power of appointment allows for additional flexibility. For example, depending on the scope of the power of appointment granted to a beneficiary (the powerholder), the powerholder could redirect to whom all or a portion of their trust share will go while they are still alive or choose new beneficiaries to receive the remaining balance of their inheritance, if any, when they die.
An article published by the American Bar Association calls the power of appointment “estate planning’s most powerful tool.” It explains that a power of appointment “is a right given to a person under a legal instrument that enables the person to further designate the recipients of property or interests in the property.”
In layperson’s terms, utilizing a general power of appointment is like giving somebody a superpower to decide who will receive your property and in what way. Here are some key features and terms to understand about powers of appointment:
- The original property holder (the person who grants the power) is known as the donor.
- The person who receives the power of appointment is called the donee or powerholder.
- When a powerholder exercises their power of appointment and names a new recipient or beneficiary of the property, those recipients are appointees.
- The property that changes hands is referred to as the appointive property.
- Depending on the scope of the power of appointment, the powerholder can determine not only who receives the appointive property but also how and when they receive it. A general power of appointment would even allow them to exercise the power in favor of themselves, their estate, their creditors, and creditors of their estate. (A limited power of appointment limits the permissible class of appointees.)
- The powerholder does not have to exercise the power of appointment. It is at their discretion.
- If a powerholder does not exercise the power of appointment, the individuals who take the property by default (according to the donor’s original will or trust instructions) are the default takers.
Reasons to Use a General Power of Appointment: Long-Term Flexibility and Taxes
A general power of appointment gives the powerholder enormous control. Why would anyone give up this degree of control over their own estate plan? Again, one reason may be the increased flexibility that enables you to account for events that occur after your death. Another reason has to do with potential tax planning strategies.
For example, your loved ones may experience changes that impact their financial status. Some may come into money (e.g., win the lottery) and no longer need an inheritance, while others may suffer a disability, develop a substance abuse issue, enter into a bad marriage, incur a great deal of debt, or display a proclivity to waste money or use it in a way you would not have approved of.
New issues like these can arise after your death when you can no longer update your estate plan. But instead of relying on distribution provisions in your will or trust that may no longer make sense or align with your goals given the new circumstances, unexpected occurrences can be indirectly planned for by granting a power of appointment to a trusted person who decides, in the future, who will receive your money and property.
A general power of appointment can also be part of a tax planning strategy. The critical thing to know is that a general power of appointment causes the property or assets subject to the power to be included in the estate of the powerholder, which has benefits and drawbacks depending on the circumstances. One benefit is that a general power of appointment may sometimes allow a person to minimize the income and capital gains tax liability on accounts and property. For example, if the powerholder has a power of appointment over trust assets that have appreciated significantly in value over time, those assets may be eligible for a basis adjustment (often called a step-up) when the powerholder dies because those assets are considered part of their estate. This could save money later by eliminating the need to pay capital gains taxes on the appreciated value. One drawback is that having a general power of appointment, which causes inclusion in the powerholder’s estate, may cause the powerholder’s estate to be subject to estate taxation depending on the powerholder’s other assets. These considerations need to be balanced carefully against the flexibility described earlier.
Do I Need a General Power of Appointment in My Estate Plan?
It is hard enough to anticipate changes tomorrow or the next day let alone those that occur years in the future, long after your death.
A general power of appointment gives an estate plan unmatched flexibility, allowing someone else to decide how to best dispose of property based on information unavailable to you when you made your estate plan. At the same time, a general power of appointment is a big responsibility with a complicated set of advantages and disadvantages that needs to be evaluated on a case-by-case basis.
If you are interested in learning more about powers of appointment, our attorneys can explain how this flexible but complex tool can be customized to fit your goals. We can also provide guidance if you have been granted a power of appointment.
Call Santaella Legal Group, serving all of California, at (925) 831-4840, or reach out to us here.