Add Estate Planning Flexibility with a Power of Appointment

The best laid plans can go awry. After your death, events may transpire that you hadn’t anticipated or couldn’t have reasonably foreseen. There’s no way of predicting the future, but you may want to supplement your existing estate plan with a trust provision that gives a designated beneficiary a “power of appointment” over some or all of the trust property. Essentially, this person will have the discretion to change distributions from the trust or even add or subtract beneficiaries.

Assuming the holder of this power fulfills the duties properly, he or she can make informed decisions when all the facts are known. This can create more flexibility and adaptability within your estate plan.

2 types of powers

There are two types of powers of appointment:

“General” power of appointment. A general power of appointment allows the holder to distribute assets to anyone, including him- or herself, his or her estate or the estate’s creditors. The property is usually included in a trust but may be given to the holder outright. Also, this power of appointment can be transferred to another person.

“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 use a general or limited power of appointment depends on your circumstances and expectations.

Tax impacts 

The resulting tax impact may also 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 is typically included in the taxable estate of the designated holder of the power. However, property included in the deceased’s estate currently 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 heirs inherit the property with a carryover basis and no step-up in basis. So, if the heirs sell appreciated property, they may be liable for high capital gains taxes.

Generally, if estate tax isn’t a concern, a general power of appointment may be preferable. We can help you determine if adding a power of appointment is right for your situation.

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