The Power of Appointment: Adding Flexibility to Your Estate Plan

One of the biggest challenges in estate planning is ensuring your family’s needs are met after your passing. Life can unfold in unexpected ways, and it's impossible to foresee every future event. While no one can predict the future, there are ways to build flexibility into your estate plan to account for changes and uncertainties.

One such tool is a power of appointment. This provision, typically included in a trust, allows a designated beneficiary the ability to alter the distribution of trust assets or even modify the list of beneficiaries based on evolving circumstances. By giving someone you trust this discretionary power, your estate plan can better adapt to future developments.

How Powers of Appointment Add Flexibility

If the person holding the power of appointment acts in accordance with your wishes and the trust’s terms, they can make informed decisions with the benefit of hindsight. This added flexibility can be particularly useful when unforeseen changes arise within the family or financial landscape.

In most cases, the holder of this power is a surviving spouse or an adult child. After your death, this individual has the authority to make adjustments within the framework outlined in the trust. For instance, if your spouse holds this power, they could determine whether grandchildren are ready to manage assets themselves or if the assets should instead be transferred to a trust managed by a professional trustee.

General vs. Limited Powers of Appointment

There are two primary types of powers of appointment, each with distinct characteristics and implications:

1. General Power of Appointment
   This allows the holder to allocate trust property to anyone, including themselves, their estate, or creditors. It provides broad flexibility, enabling the transfer of assets either within the trust or outright to the holder. Additionally, the holder of a general power can pass this power to another person if needed.
2. Limited (or Special) Power of Appointment
   A limited power of appointment is more restrictive. The holder can only allocate assets to a predefined group of people, typically named by the person who created the trust. For example, a surviving spouse might have the power to distribute assets among the children, but they wouldn’t have the authority to direct assets elsewhere.

The choice between a general or limited power of appointment depends on your estate planning objectives and the level of control you want to provide.

Understanding the Tax Implications

The decision between a general or limited power of appointment can also have significant tax consequences. While the rules are complex, here are some key differences:

• General Power of Appointment: Property subject to a general power is typically included in the taxable estate of the holder. However, this property benefits from a step-up in basis, meaning the property’s value is adjusted to its fair market value at the time of death. As a result, your heirs may be able to sell the property with minimal or no capital gains tax.
• Limited Power of Appointment: Property governed by a limited power is not included in the holder’s estate, so it doesn’t receive a step-up in basis. Instead, heirs inherit the property with its original carryover basis. If they later sell the property, they could face significant capital gains taxes on the appreciated value.

Choosing the right type of power of appointment is crucial and should be informed by an in-depth analysis of your tax and financial situation. Working closely with an estate planning advisor can help ensure that your decisions align with your long-term goals.

HoganTaylor Estate Planning Services

HoganTaylor estate planning professionals leverage their tax and business advisory expertise to help individuals accomplish goals and minimize tax burden. If you have any questions about the content of this publication, or if you would like more information about HoganTaylor's Estate Planning services, please contact Dan Bomhoff, Estate Planning  Lead.

INFORMATIONAL PURPOSE ONLY. This content is for informational purposes only. This content does not constitute professional advice and should not be relied upon by you or any third party, including to operate or promote your business, secure financing or capital in any form, obtain any regulatory or governmental approvals, or otherwise be used in connection with procuring services or other benefits from any entity. Before making any decision or taking any action, you should consult with professional advisors.