Our firm, and many estate planning professionals are big advocates of creating lifetime trusts for spouses and descendants.  Leaving an inheritance in a trust for beneficiaries is a gift of tremendous asset protection, since the trust funds will not be lost in divorce, in bankruptcy or to judgment creditors.

When these lifetime trusts are created, then the question often arises of “what happens to the assets remaining in the trust after the death of the beneficiary?”  The answer often turns on the existence of powers of appointment. If there is no power of appointment, the  language of the will or the trust which created the lifetime trust says who inherits upon the death of the primary beneficiary.  Sometimes, however, the person creating the trust for the spouse or children desires to allow the beneficiary to decide who gets the remaining trust property upon the death of the beneficiary.  This can take place through granting a beneficiary either a general or limited power of appointment.

General powers of appointment allow the beneficiary to leave the trust assets to any person or entity. Limited powers of appointment allow the beneficiary to leave the remaining trust property to only a select group of potential beneficiaries defined by person who created the trust.  Some clients feel strongly that the trusts they set up should stay within the family.  These clients often give their spouses or children a limited power to appoint only among their descendants.  Others will include charities and/or spouses to broaden the options of the beneficiaries.  Limited powers of appointment give these clients the ability to share control with their beneficiaries.  The client defines the group, and the beneficiary decides who within the group and how (either outright or in trust).

Selecting the type of power of appointment is sometimes driven by tax considerations.  General powers of appointment results in the beneficiary’s trust being included in the beneficiary’s taxable estate for estate tax purposes, which is bad if it results in having to pay 40% of the trust funds to the tax man.  On the other hand, if the trust property together with the beneficiary’s own estate is below the estate tax exemption, estate tax inclusion is often desirable, as it gives the appointees a step up in basis of trust assets to date of death values as of the death of the beneficiary.  This can result in a generation of appreciation passing on tax free.

But regardless of tax implications, the use of powers of appointment give beneficiaries the ability to see how their descendants mature as they age, so they may tailor trusts to meet the needs of their children.  The trust established for a responsible child might be much different than the one set up for a special needs child or an addict.  If we trust our spouses and children to chose wisely in how they provide for their loved ones, this gift of flexibility can be a great tool to give our loved ones.

It is also important to know whether a trust set up for you contains a power of appointment, so that it can be properly exercised in compliance with the terms of the will or trust that created the power.

If you want additional information regarding powers of appointment and how to use them in estate planning, please reach out to us.

 

Michael G. Carroll