You've probably spent considerable time thinking about your estate plan and what objectives it should achieve.
Unfortunately, after you're gone, unanticipated events can thwart your best laid plans. But a "power of appointment" can provide your estate plan with flexibility and adaptability.
This is an estate plan provision that gives a designated beneficiary some control over some or all of your trust's property. Assuming this person fulfills the duties properly, he or she will have the discretion to change distributions from the trust or even add or subtract beneficiaries. Let's take a look.
Authority to Make Changes
Typically, a trust will designate a surviving spouse or an adult child as the holder of the power of appointment. After you die, this holder has authority to make changes consistent with the language contained in the power of appointment clause. This may include the ability to revise beneficiaries.
For example, if you give your spouse power of appointment, he or she can later decide if grandchildren are capable of managing property on their own or if property should be transferred to trusts managed by professional trustees. The power of appointment can be used to discourage spending sprees of offspring who haven't demonstrated the ability to handle newfound wealth.
General and Limited Powers
There are two types of powers of appointment. The first is "general" power of appointment. This allows holders of the power to appoint the property for the benefit of anyone, including themselves, their estate or the estate's creditors. The property usually is included in a trust but may be given to the holder outright. Also, this power of appointment can be transferred to another person.
The second type is "limited" or "special" power of appointment. Here, the person holding the power of appointment can give the property to a select group of people who've specifically been identified by the deceased. For example, it might provide that a surviving spouse can give property to surviving children, as he or she chooses, but not to anyone else. Thus, this power is more restrictive than a general power of appointment. Whether you should adopt this limited power or a more general power of appointment depends on your circumstances and expectations.
Minimizing Tax Consequences
The resulting tax impact may affect your decision to use a general or limited power of appointment. The rules are complicated, but property subject to a general power of appointment typically is included in the taxable estate of the designated holder of the power. However, property included in the deceased's estate receives a step-up in basis to fair market value on the date of death. Therefore, your heirs can sell property that was covered by a general power of appointment with little or no income tax consequences.
In contrast, property covered by a limited power isn't included in the holder's estate. However, the new heirs inherit the property with a carryover basis and no step-up in basis. So, if the heirs sell appreciated property, they face a potentially high capital gains tax.
To help ensure you make the right decision for you, consult an estate tax advisor. Keep in mind that property subject to estate tax can be sheltered by the federal gift and estate tax exemption. The exemption is $12.06 million for 2022. If estate tax isn't a concern, a general power of appointment may be preferable.
Conversely, a limited power of appointment may be used if capital gains will be relatively small or postponed indefinitely. This may be the case for, let's say, a vacation home that has remained in the family for generations.
The power of appointment isn't automatic when you establish an estate plan or set up a trust. Discuss the option with your estate planning advisor to determine if it makes sense given your particular circumstances.