What is a Power of Appointment?
A power of appointment is a power given to a person (oftentimes under a trust) which enables the person to designate who will receive property or an interest in property. The person who creates the power of appointment is the donor; the holder of the power is the powerholder; and the possible recipients of the property are the permissible appointees.
A power of appointment may be general or limited. A general power of appointment is a power that the powerholder may exercise in favor of himself, his estate, his creditors or the creditors of his estate. A nongeneral power of appointment is commonly referred to as a limited (or special) power of appointment and may be exercised in favor of anyone other than the powerholder, his estate, his creditors or the creditors of his estate.
If Bob creates a trust under his will for the benefit of his wife, Susan, and gives Susan a power of appointment which may be exercised in favor of Bob and Susan’s children, Tom and Mary, and their descendants, but not in favor of Susan, her estate, her creditors or the creditors of her estate, Bob is the donor; Susan is the powerholder and she has a limited power of appointment over the trust; and, Tom and Mary and their descendants are the permissible appointees.
Advantages and Disadvantages of Powers of Appointment
One of the most common reasons to include a power of appointment in your estate planning is to provide flexibility. When you create a will or an irrevocable trust, once it becomes effective, the document cannot be changed. But, what if circumstances change? What if your will leaves assets outright to a beneficiary who becomes disabled and can’t manage her own finances? What if tax laws change? Through the use of a power of appointment, the powerholder can change the terms of a trust, the beneficiaries, the method of receiving property (e.g., outright or in trust), or trustee. Powers of appointment create an opportunity to make changes to an estate plan after taking future circumstances into consideration.
Let’s say Bob leaves his entire estate, $10 million, in trust for susan and the trust provides that at Susan’s death, the trust’s remaining assets will be distributed outright to Tom and Mary, provided they have reached age 25. After Bob’s death, Susan decides that $5 million is a lot of money for Tom and Mary to receive outright at age 25; she would rather their inheritance be held in trust for them until they reach age 40. If Bob gives Susan a power of appointment over the trust, Susan can exercise that power to provide that the assets remaining in the trust at her death will be held in trust for Tom and Mary until they reach age 40 (rather than distributed outright to them at age 25).
The most common reason not to include powers of appointment in your estate plan is because the donor must give up control over the disposition of the assets. If you give someone a power of appointment, then that person (the powerholder), not you, will control the ultimate disposition of the assets. Giving up control may not appeal to you and in some cases may not be a good idea. For example, Bob and Susan divorce, Bob gets remarried to Ann, and at Bob’s death he leaves his entire estate in trust for Ann. Bob wants to ensure that at Ann’s death, the remaining trust property will be distributed equally to Tom and Mary. In that case, Bob should not give Ann a power of appointment if he does not want Ann to control how the remaining trust property is distributed at her death.
There are also technical reasons why a power of appointment may be disadvantageous. For example, assets subject to a general power of appointment will be included in the estate of the powerholder; under some circumstances, that could create unfavorable tax consequences. Also, if a limited power of appointment is exercised improperly, it could become a general power of appointment.
If flexibility in your estate plan is important to you, you should discuss powers of appointment with your attorney to determine whether and what type of power of appointment may be appropriate for your circumstances.
Are You a Powerholder?
You may have a power of appointment under someone else’s estate planning documents. It is not uncommon for one family member to give another family member a power of appointment. If you are (or think you are) a powerholder, you should discuss your power of appointment with your attorney to determine whether you should exercise your power of appointment and the consequences of doing (or not doing) so.
