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When selecting a successor trustee for a trust, it is common for the individual who creates the trust (the trustmaker) to choose one person to serve as a successor trustee at a time. Some attorneys routinely recommend that only a single successor trustee be appointed to avoid the potential for conflicts between co-trustees during trust administration. This can be a prudent approach and works well in many situations. This is particularly true when the appointed trustee diligently keeps the beneficiaries of the trust informed about the trust administration and carefully fulfils the trustee’s responsibilities under both the law and the provisions of the trust document.
 
However, many trustmakers are reluctant to place the entire responsibility for trust administration on only one person. As a result, it is increasingly common for a trustmaker to nominate two or more family members or friends to serve as successor co-trustees. In some cases, it may even be beneficial to divide the trustee responsibilities between a professional trustee and a family member trustee. For example, a professional trustee might be given the responsibility for trust investments or accounting and tax matters, and the family member trustee may be asked to handle certain distribution responsibilities, such as the timing and amount of distributions to a minor beneficiary. While this co-trustee approach can have some drawbacks, it also has benefits that may be worth considering.
 
Advantages and Disadvantages of a Co-trustee Approach
Choosing multiple individuals to serve as co-trustees offers the following advantages:

• Co-trustees can provide checks and balances to guard against potential abuses of authority.

• Sharing or separating the responsibilities of trust administration among co-trustees can expedite the efficient administration of a trust.

• Depending on the terms of the trust, a particular co-trustee may be able to respond quickly to an emergency situation if no other co-trustees are available.

• Trust beneficiaries may be more likely to accept the actions and decisions of unified co-trustees as opposed to the decisions of a single trustee.

• Administrative responsibilities can be allocated among the co-trustees based on each co-trustee’s unique strengths and skills or in a fair and equitable manner.

However, there are also disadvantages to consider:

• Disagreements between co-trustees can lead to conflicts or stalemates.

• Delays can result if the trust requires that all co-trustees be present and act together to conduct trust business.

• Financial institutions, individuals, and businesses may be reluctant to take direction from fewer than all co-trustees, even if the trust document authorizes a single co-trustee to act.

• Compensating multiple co-trustees for their time spent handling trust business can result in potentially higher costs.

What Is the Right Approach for You?
Before you decide whom to name as a successor trustee, you should discuss these advantages and disadvantages with your attorney and other professional advisors well before there is a health event that could lead to your incapacity (the inability to make your own decisions) or death. Doing so will help you identify some of the potential pitfalls and complications that can arise with regard to your successor trustee choice. These discussions may also help you realize that you need to make changes to your estate planning documents, either to add another family member or a professional fiduciary as successor co-trustee or to remove certain individuals listed as a co-trustee because of the potential for conflicts. Of course, we welcome the opportunity to meet with you to discuss ideas and make any necessary updates to your estate documents so that they better match your intent.
 
As you prepare for these discussions with your attorney and other professional advisors, it may be helpful for you to consider some of the following questions before ultimately deciding whom to name as your successor trustee:
 
How well does the individual I want to name as trustee work with others?
Does your potential successor trustee have the temperament to delicately handle requests, questions, and perhaps even emotional outbursts from the trust beneficiaries while administering the trust? Do they handle conflict well, or do they have a tendency to escalate conflict when they encounter it? How might serving with a co-trustee mitigate or exacerbate this temperament?
 
Does the person you plan to name as trustee have sufficient time and flexibility for their duties?
Being a trustee requires a certain level of flexibility and availability. If your chosen trustee is a busy professional or a busy parent with little extra time to spend handling the trustee’s many tasks, would it make sense to nominate multiple co-trustees to share those responsibilities? On the other hand, would naming multiple trustees create frustration if the co-trustees are all required to be present to handle certain financial or administrative tasks? Sometimes, the need for flexibility calls for fewer, not additional, trustees.
 
If co-trustees are named, should they have authority to act independently?
While having multiple co-trustees can provide important checks and balances, should they nevertheless be given independent authority to act on behalf of the trust? Granting such authority may decrease the hassle of needing to have all co-trustees present but still provide the ability to spread responsibilities among the various co-trustees, thereby decreasing the workload of each co-trustee.
 
If multiple co-trustees are chosen, what method might be used to resolve a stalemate in trustee decisions?  
Even co-trustees who normally get along can sometimes disagree so strongly that a stalemate occurs. In such a case, what might be an appropriate way to resolve the impasse? Should another family member be named to break the tie? What about a trusted professional advisor, a mediator, or a trust protector? Or should differences like these only be resolved by a court? Often, leaving such decisions to a court can encourage disagreeing co-trustees to resolve the dispute on their own in an effort to avoid the expense and delay of going to court.
 
You might also request that your attorney include language in your trust that permits a dissenting co-trustee to abstain from participating in a decision, thereby limiting the dissenting co-trustee’s liability for any harm that might result from the other co-trustees’ decision. This approach allows the business of the trust to move forward, even over the objection of a co-trustee. However, the dissenting co-trustee would have the comfort of knowing that the overruling co-trustees would ultimately be the only ones responsible for those particular actions.
 
Conclusion
Whether you nominate a single successor trustee or multiple co-trustees, carefully considering the pros and cons of each approach can help ensure that your wishes for the handling of your estate and trust will be honored. Contact us today so we can review your current successor trustee selections or create an estate plan with the right people in charge to assist you when needed.

When we think of estate planning, we often think about preparing our accounts and property to go to our loved ones in a tax-efficient way, protected from probate, disgruntled heirs, beneficiaries’ creditors, divorcing spouses, bankruptcy, and the poor spending habits of children or other beneficiaries. We rarely consider preparing for receiving an inheritance of our own.
 
Believe it or not, there are some essential things you must consider when you anticipate receiving an inheritance. Understanding these issues can be crucial to protect that inheritance from unnecessary taxes and outside threats like creditors, divorcing spouses, and bankruptcy.
 
Understanding the Nature of the Property to Be Inherited
The first way to properly prepare to receive an inheritance is to discover what you will be inheriting. Is it real estate, a 401(k), or an individual retirement account (IRA)? Perhaps it is publicly traded stock, an interest in a family business, or just simply cash from a savings account or life insurance policy.
 
Whatever it is, there are steps you can take today to plan to receive and manage it properly. For example, if you will receive a large IRA account from a parent, do you understand the new rules associated with inherited IRAs as implemented by the SECURE Act passed in late 2019? If not, you should educate yourself now on how to maximize the tax benefits available under the law regarding required distributions. Without an understanding of these often complicated rules, you could make an irreversible mistake and withdraw all of the IRA funds at one time, thereby substantially increasing your tax liability in the year of withdrawal. There are a variety of nuances to these rules that a tax adviser or attorney can help you understand and navigate properly.
 
Likewise, if you are receiving rental property as a part of your inheritance, you should consider the business of being a landlord and if you even have an interest in continuing to operate such a venture. If not, you may want to prepare to find a buyer for the property who can offer you a fair price as soon as possible. Or, at the very least, look into hiring a property management company to take over as soon as you inherit the property.
 
Powers of Appointment
If your loved one has completed trust planning that includes establishing an irrevocable trust for you, such trusts frequently include important features that are generally referred to as powers of appointment. A power of appointment in a trust is a right, often given to the beneficiary of the trust, to gift trust property to someone else or, in some cases, to yourself. These powers are often limited to making gifts to only certain classes of people (such as the descendants of the trustmakers), or they may be limited to making gifts only at death (a testamentary power of appointment) or during life (a lifetime power of appointment). Some trusts include both types of powers. These can be powerful planning tools that have been given to you through trust documents. Failure to recognize the existence of these powers can lead to unintended consequences, or at the very least, crucial missed asset protection and tax-planning opportunities.
 
If you know that you have been granted a power of appointment, you should attempt to obtain a copy of the relevant trust documents to carefully review and determine the nature of these powers. An experienced estate planning attorney can help you with this task. With this information, your professional advisers can properly advise you on the planning opportunities and tax consequences of the powers of appointment that may be available to you.
 
Keeping Inheritance Separate from Marital Property
A common mistake made by married individuals who receive an inheritance is to commingle that inheritance with the property of both spouses. How can this be a mistake? An example may best illustrate the point:
 
Imagine Robin receives a cash inheritance from her deceased father of $300,000 and she and her spouse Morgan decide to use the inheritance to buy a vacation cabin in the mountains. When purchasing the property, the title company assumes that because they are a married couple, they want to take title to the property as joint tenants with rights of survivorship and the deed gets prepared and recorded accordingly. Further imagine that over the years, they furnish the property together, maintain it, and enjoy many family vacations there. One night, however, Morgan has a little too much to drink at a bar, gets behind the wheel, and causes a deadly accident that results not just in a DUI, but also in a wrongful death lawsuit. Because Morgan’s name is on the title to the property as a joint owner, Robin and Morgan discover that the family cabin is an asset that can be used to satisfy the lawsuit judgement against Morgan. As a result, they are forced to sell the cabin and use half of the proceeds to satisfy the judgement.
 
This unfortunate circumstance can be the result of Robin’s failure to keep her inheritance as separate property. By commingling her property with Morgan, she made it much easier for the judgment creditor in the lawsuit to reach what otherwise would have been considered Robin’s separate inheritance property.
 
Commingling inherited property can also lead to a similar result if Robin and Morgan ultimately divorce and the family court judge has to determine how to divide the marital property. Failing to keep the inherited property separate during marriage can often lead to that property being divided between spouses at divorce.
 
Inheritor’s Trust
A fourth way for you to prepare to inherit property is by using an inheritor’s trust. This is a special type of trust that can be established by the individual who will be leaving an inheritance to you. An inheritor’s trust is designed to receive the inheritance that you would otherwise receive directly. It must be carefully designed and implemented to work properly, and an experienced estate planning attorney should most certainly be used in the effort. A properly drafted inheritor’s trust includes the following key elements:

• It is created and signed by the individual who will be leaving you an inheritance, not by you

• The trust creator names the trust instead of you as the beneficiary of their will or revocable living trust

• It typically has a spendthrift clause or is otherwise designed to protect the inherited property from creditors, divorcing spouses, lawsuits, bankruptcies, etc.

• You are the beneficiary of the inheritor’s trust

• You may also be named as the trustee or co-trustee of the inheritor’s trust, depending upon how protective the trust needs to be of the trust property 

An inheritor’s trust includes the following benefits:

• The inheritance can be excluded from your taxable estate, potentially saving your family estate taxes

• The trust can be a more cost-effective way to protect the assets instead of your loved one revising their existing plans

• Upon your own death, the inheritance will be distributed outside of your probate estate, which can help ensure privacy and lower attorneys fees and administration costs

• The inheritance will likely be protected from creditors, lawsuits, and divorcing spouses

• In some circumstances, the inheritance can even be controlled and managed by you as a trustee

• You can decide how remaining trust assets will be distributed after you pass away if the trust gives you that power (through powers of appointment)

An inheritor’s trust can be a powerful tool to use when you anticipate receiving a large inheritance and would like to make sure that the inheritance is protected from certain tax consequences or threats from creditors.
 
If you would like to learn more about any of these concepts, give us a call. We would love to discuss these ideas in greater depth with you so we can help you build and protect your wealth more effectively.

Estate planning attorneys frequently hear from their clients, “I’d like to leave something to my grandchildren. What’s the best way to do that?” 

Naturally, grandparents love their grandchildren and want them to succeed in life. And when grandparents are in the twilight of their lives, their hearts often turn to the younger generation with a desire to give them whatever advantages they can, especially if they were unable to give their own children those same advantages when their children were younger.

For most grandparents, the best way to provide for their grandchildren is to leave their accounts and property to the grandchildren’s parents to ensure the financial stability of that family unit, thereby indirectly benefiting the grandchildren. In fact, default inheritance laws in nearly every state reflect this common desire to provide first for children and then for the grandchildren in the event that an adult child predeceases the grandparent. From a practical perspective, the grandchildren’s parents are often in the best position to know how to use the money for the benefit of their children and can spend or invest it appropriately on their behalf.

In some cases, however, it makes better sense for grandparents to leave property to their grandchildren—for example, if the grandparents have reason to believe that their own children would not responsibly use the money intended for the benefit of the grandchildren, or if the grandchildren’s parents are independently wealthy and distributing the property to them would unnecessarily expose the property to estate tax in their estates. In some cases, although the intent of grandparents may have been to leave everything to their adult children, an inheritance may flow to grandchildren unintentionally because of an accident or illness that prematurely takes the life of an adult child. In any of these situations, it is important to consider the possibilities and the options for leaving an inheritance to grandchildren. Failing to do so can have long-lasting consequences and, in many cases, do more harm than good.

The Trouble with Outright Gifts

Perhaps the simplest way to leave an inheritance to your grandchildren is to name them as beneficiaries in your will or trust to receive a specific amount of money or a percentage of your total accounts and property. If all of the grandchildren who will receive such gifts are physically and emotionally stable, financially prudent, and have reached adulthood, this strategy may work just fine and reduce the administrative burden of managing and distributing your accounts and property to the beneficiaries or heirs.

However, depending on when you pass away, if any of the named grandchildren are minors, you could create additional hassles by leaving a gift directly to them. The executor of your estate or the trustee of your trust may have to establish certain types of custodial accounts to hold that gift for the minor child until they have reached the age of majority (either age eighteen or twenty-one depending on the state). In some states, and depending upon how much money is involved, establishing a court-controlled conservatorship over the property may be required. In other cases, setting up an account using the Uniform Transfers to Minors Act laws of the state may be all that is necessary. In either of these cases, however, once the child reaches the age of majority, you may not be able to control how that money is used by the grandchild. It could be spent on fast cars and fancy clothes rather than on an education, starting a business, or a down payment on a home as you might have imagined. In a worst-case scenario, a grandchild might even unwisely invest it with a spouse who later divorces them, or with an unscrupulous business partner who preys upon inexperienced individuals who have come into a sum of money.

By being aware of these risks, you can take steps today to make sure that any of your property that ends up in the hands of your grandchildren is protected from not only your grandchildren’s own poor spending choices but also the claims of a divorcing spouse, an unethical business partner, or an opportunistic lawsuit filed by a stranger against your grandchild.

Using Trusts for Gifting to Grandchildren

A trust offers one of the most flexible methods for leaving an inheritance to grandchildren. When you leave an inheritance to grandchildren via a trust, you can ensure that the money and property are used appropriately and at appropriate times. There are a variety of ways to use trusts in your estate planning. You can add provisions to your will or revocable living trust that instruct the executor or trustee to hold any property that is payable to a grandchild in a separate trust share rather than making a direct distribution of the accounts or property to them. You can specify in those trust terms how the money is to be used or distributed and when. These can be very important provisions to include in your trust even if you are planning to leave your accounts and property only to your children. As mentioned, it is possible for your child to pass away before you do in an accident or from illness. And if your child has children of their own and you want your child’s share to go to their children, it can be crucial to have a trustee protect and manage it until it can be distributed to the grandchildren at a more appropriate time.

Another way to use trusts is to create the trust during your lifetime, name yourself as the trustee, and transfer some of your property into the trust for the benefit of your grandchildren. From a tax perspective, you can make gifts to this trust using the annual gift tax exemption (currently, $15,000 per beneficiary of the trust per year) to shelter the gifts from transfer taxes. Gifting in this way during life allows you to have confidence that the trust is set up appropriately and enables you to enjoy watching your grandchildren actually benefit from the trust. You can also feel confident that once you pass away, your grandchildren and even your great-grandchildren will continue to benefit from the property in the trust, if that is your goal.

Health and Education Exclusion Trusts

Beyond the traditional use of trusts in your estate planning, you can also design special trusts to provide additional tax benefits if your estate is large enough to potentially be subject to the generation-skipping transfer (GST) tax. A health and education exclusion trust (HEET) is one of these special types of trusts. A HEET is designed to make use of certain tax code provisions that exclude from lifetime gifts any amounts paid directly to healthcare and education institutions on behalf of someone. A HEET can be designed to name, as beneficiaries, any number of your grandchildren or succeeding generations, if desired. The funds in the trust can then be used to pay for health and education expenses directly on behalf of the beneficiaries without being subjected to gift taxes in the future. Furthermore, the distributions to the beneficiaries will be exempt from the GST tax. This benefit is obtained by naming a charitable institution as an additional beneficiary of the trust. As long as the trustee makes regular and reasonably substantial distributions to the charitable beneficiary from the trust, the distributions to the other beneficiaries will be GST tax-exempt.

A HEET is worth considering if (1) you would like to help your grandchildren and succeeding generations with their education and medical expenses, (2) you have used up your GST tax exemption amount through gifting or other estate planning strategies, and (3) you want to benefit a charitable organization as part of your estate planning.

Generation-Skipping Transfer Taxes

Although we have mentioned GST taxes in passing, it is important to remember that whenever you are including grandchildren in your estate planning, you should seek advice from your attorney or accountant with regard to this unique form of taxation. For most people with modest accounts and property, the GST tax is not a significant issue. However, if what you own is valued at more than the current estate tax exemption amount, the GST tax is something that you should be aware of and plan around, particularly if you anticipate that any amount of your property will eventually be distributed to your grandchildren. You should also be aware of the GST tax if you are creating trusts specifically for your grandchildren and their descendants. You may need to take certain steps upon creation of such trusts to ensure that the trust is GST tax-exempt. Your tax professional can provide you with important guidance on this point.

Keeping Parents in the Loop

Grandparents often overlook bringing parents into the conversation when planning for their grandchildren. Consequently, some grandparents have been unpleasantly surprised at the negative reactions from their own children or in-laws when they make generous gifts to their grandchildren. Depending on a family’s parenting philosophy, the grandchildren’s parents may resent an unexpected, large sum of money or payment for certain expenses. Instead of seeing it as a boon, a parent could see it as a grandparent interfering in the character development of their children, robbing them of important opportunities to become financially independent, learn important life lessons about sacrifice and hard work, such as qualifying for merit-based scholarships, and the value of money in general. Speaking beforehand with your grandchildren’s parents about how you can best support the development of your grandchildren into responsible adults can go a long way toward ensuring that your gifts will be appreciated and truly beneficial.

Conclusion

Whether you want to specifically and intentionally include your grandchildren in your estate planning or just want to make sure that they are carefully accounted for in the event that they unexpectedly inherit your property, it is critical to examine your estate planning with your attorney to make sure that your plan reflects your wishes and your family’s values. Beyond making sure your property gets to the right people at the right time, careful planning with the help of your tax professionals can also ensure that significant tax savings are preserved, thereby keeping more money in the hands of your family and out of the hands of the government.

This year has been unprecedented from a political perspective in many ways. President Joe Biden stepped into office facing huge obstacles related to the COVID-19 pandemic, an economy battered by the pandemic, a crumbling national infrastructure in dire need of repair, an ongoing immigration crisis at our southern border, and deep political and social divisions in this country, among other challenges.
 
As Biden entered office, he named the following issues as his top priorities:

1. Getting past the COVID-19 pandemic through masking, vaccinations, and opening schools

2. Addressing climate change and alternative energy solutions

3. Financial regulation and student debt

4. Anticompetition practices among the leading companies in Big Tech

5. Revitalizing the economy and employment to recover from the pandemic

6. Improving international relations

7. Immigration

8. Race, gender, and social issues

With these issues at the top of Biden’s priority list, it may appear that no real changes are coming down the pipeline that are directly related to the estate plans of most Americans of average means. But if recent history is any guide, although many of us hope that the estate planning landscape will remain settled and predictable, it is unlikely that we will be so lucky. Here’s what we know so far with regard to proposals coming from the White House.
 
Action from the First One Hundred Days That Could Affect Your Estate
While many of the issues Biden has prioritized have begun to be addressed within his first one hundred days in office, many of them are still in their infancy, with the details of how they will be implemented and funded still to be determined. The following steps have already been implemented or proposed in Biden’s plan:

1. In early March, Biden signed a $1.9 trillion COVID-19 relief bill (named “The American Rescue Plan”), providing stimulus payments, unemployment benefits, and child tax credits to millions of Americans to help stimulate the economy.[1]

2. On March 31, through the “American Jobs Plan,” Biden outlined a nearly $2 trillion infrastructure and jobs plan that is to be funded primarily through a corporate tax hike and additional measures designed to discourage U.S. corporations from moving their operations overseas to reduce or eliminate U.S. taxation (i.e., “offshoring”).[2]

3. The American Rescue Plan also allocates significant funding for providing vaccinations to all Americans at no cost, and additional funds to help the nation’s food service industry and K-12 schools survive the financial impacts of the pandemic.[3]

4. The proposed “American Families Plan” by the White House in late April is also designed to help families cover basic expenses, gain greater access to health care insurance, and reduce child poverty through the use of child tax credits and similar measures.[4]

These large spending bills, both passed and proposed, will need to be funded in some manner. Some of the possibilities for funding this spending include the following changes to the tax laws that could have a significant impact on your estate planning:[5]

1. Increase IRS enforcement efforts of wealthy taxpayers. The White House has determined that significant tax revenues are being left on the table due to the inability of the IRS to enforce current tax laws. Biden has proposed increased funding of the IRS to enforce laws against tax avoidance abuses and increase audits to ensure taxes that are in fact owed are being assessed and collected.[6]

2. Elimination of the rule of step-up in basis at death. This proposed change to the tax code would eliminate the benefit of receiving a step-up in tax basis on inherited property in the hands of a deceased individual’s heirs and beneficiaries for gains in excess of $1 million (or $2.5 million per couple when combined with existing real estate exemptions). This could result in significant capital gains taxes being assessed upon the sale of the property once it has been inherited. However, certain exceptions to this rule for small business owners and farmers would be preserved under the proposed legislation.[7]

3. Increases in top income tax rate. Another Biden proposal under consideration is the increase in the top individual tax rate from 37 percent to 39.6 percent and elimination of the lower capital gains tax rates otherwise available for those earning over $1 million annually. Rather, capital gains would be taxed as ordinary income for those earning over $1 million annually.[8]

4. Reducing potential benefits of 1031 exchanges. The President is calling on Congress to reduce the benefits available with the special tax break that allows real estate investors to defer paying capital gains taxes when they exchange properties.[9]

Flexibility Is Key in These Uncertain Times
We are living in a time of significant uncertainty when it comes to estate planning and the economy. As a result, it is more important than ever to ensure that your estate plan is designed in a way that enables you to move quickly and take advantage of estate and tax planning opportunities that arise.
 
Additionally, there remain many non-tax-related reasons to keep your estate plan up-to-date and relevant to your circumstances:

• Protecting your property for the benefit of your loved ones. Careful estate planning can do more than just avoid taxes. You can also ensure that your loved ones are the only people to benefit from your wealth by protecting their inheritance from threats such as lawsuits, bankruptcy, divorcing spouses, and poor management and spending habits. By using various estate planning techniques such as trusts, LLCs and family limited partnerships, and exempt property planning, significant protections can be created for your loved ones.

• Avoiding probate courts. Quality estate planning frequently incorporates a variety of probate avoidance techniques, such as using fully funded trusts, proper beneficiary designations, and lifetime transfers to beneficiaries. By avoiding probate, you can ensure your family’s privacy and prevent needless court interference and challenges to your estate planning.

• Planning for incapacity and your long-term care. Using powers of attorney, healthcare directives, trusts, and healthcare privacy information authorization documents, you can ensure that only those whom you trust to manage your healthcare decisions and finances are the ones to do so if you ever become incapacitated.

Keeping abreast of the whirlwind of changes in the law and the economy can be a tall order for anyone when it comes to maintaining your estate planning. That is why having an estate plan with appropriate provisions that allow for flexibility is so important. We are prepared to keep you apprised of the legislative changes that are headed our way and will help you stay informed so you can move quickly if changes to your planning become necessary. We always welcome a call from you to set up an appointment with our office to discuss your estate plan. Together, we can make sure you are prepared for whatever may come.

[9] Id.

An often misunderstood but common estate planning tool that can appear in estate planning documents is the power of appointment. Not to be confused with a power of attorney (the document that allows you to delegate certain powers to an agent to act on your behalf while you are still living), a power of appointment can be an incredibly useful tool if used properly and knowledgeably.
 
A well-considered power of appointment allows you to maintain significant flexibility in your estate plan now and in the future, even when that estate plan is otherwise considered irrevocable under the law. Though hundreds of pages of books, scholarly articles, court decisions, and tax regulations have been written on the topic of powers of appointment, this newsletter can help you identify opportunities in which powers of appointment may be useful and recognize cases in which they can create negative consequences.
 
What Is a Power of Appointment?
Broadly speaking, a power of appointment is a right granted in a legal document, including in a will or a trust, by an individual (the donor) to another person (the donee or the power holder). This granted power allows the donee to name someone else as a recipient (the appointee) of all or a portion of the donor’s money and property in the future. The power holder is not required to exercise the power. Rather, the power holder simply has the option to exercise it. If the power is left unexercised, then the money and property will pass to those individuals or entities who were originally named in the will or trust as the beneficiaries and in the amounts originally specified. This tool essentially allows for the person making a will or trust to postpone the decision of who should receive the donor’s money and property, and grants such decision-making power to someone else who may be in a better position in the future to determine who will receive it.
 
General Versus Limited Powers of Appointment
In trust law and tax law, there are two types of powers of appointment: (1) a general power of appointment and (2) a limited power of appointment (also known as special or nongeneral powers of appointment). A general power of appointment is, with only a few exceptions, a power that is exercisable in favor of the decedent, their estate, their creditors, or the creditors of their estate.[1] If a power of appointment does not fit within the definition of a general power, then it is, by default, a limited power of appointment. A common example of a limited power of appointment is a power that is limited to distributions for health, education, maintenance, or support of a beneficiary (called the HEMS standard). Another example is a power granted to a power holder to distribute the property among a limited group of individuals, for example, among only “your descendants.”
 
Lifetime Versus Testamentary Powers of Appointment
An additional characteristic that can be applied to a power of appointment is whether the power is to be a lifetime power of appointment or a testamentary power of appointment. The difference has to do with the particular moment that the power can be exercised by the power holder. For example, if a power of appointment gives the power holder a power to distribute property among grandchildren only while the power holder is alive, this would be a lifetime power of appointment. However, because this is also a limited power of appointment, we can refer to this power as a lifetime limited power of appointment. Similarly, if a general power of appointment is granted, but only for life, then it would be a lifetime general power of appointment.
 
On the other hand, if a power of appointment (either limited or general) is granted to a power holder that can only be exercised at the power holder’s death, then this would be considered a testamentary power of appointment. Typically, a testamentary power of appointment must be exercised through a provision in the powerholder’s will or trust that specifies how the property subject to the power is to be distributed upon the power holder’s death. Thus, someone could be granted either a testamentary limited power of appointment or a lifetime limited power of appointment, or a testamentary general power of appointment or a lifetime general power of appointment.
 
Why Use Powers of Appointment?
There are a variety of reasons why someone might want to use a power of appointment in their estate plan, including tax considerations, asset protection, and a desire for flexibility. The following are a few examples that can help illustrate how and why a power of appointment may be used:

1. Sarah creates a trust that is designed to hold her property for the benefit of Dave, her only son, for his lifetime, and which will then pass to his children upon his death. However, three of her grandchildren have a history of drug use, terrible spending habits, and have even attempted to financially exploit her in the past. Although Sarah wants only her grandchildren to benefit from the trust after her son dies, she wants to allow Dave to determine how much (if anything) should go to each of her grandchildren, depending on how they conduct their lives in the future and what their needs are. Sarah’s estate planning attorney suggests that she grant Dave a testamentary limited power of appointment in her trust that allows Dave to distribute the remainder of the trust property according to how he sees fit among his children, in equal or unequal shares at his death. This will require Dave to draft a will or trust that includes a provision that specifies how the remainder of Sarah’s trust will be divided among his children at his death. Including such a power allows Sarah to maintain some control over who will receive her property, but also grants some important flexibility in her estate plan to her son so that he can take a second look at the family circumstances years after Sarah has passed away.

2. Marty died, leaving a trust that owns a significant amount of quickly-appreciating corporate stock shares. His only daughter Betty is the income beneficiary of the trust and enjoys the stock dividends that are paid out to her every year. Betty’s children are the remainder beneficiaries of the trust. Betty is in her late eighties and is experiencing failing health. Before Marty died, he amended his trust to ensure that it contained a provision that granted Betty a testamentary general power of appointment over the trust. As a result, upon Betty’s death, the stock in the trust receives a full step up in tax basis under current federal tax law, thus eliminating the capital gains taxes that would have otherwise been due on the sale of the stock in the hands of Betty’s children after her death. Significant tax savings are achieved by including this type of a power of appointment.

3. John is Karen’s second husband. Karen has children from a previous marriage. John has never been married and has no children of his own. Some of Karen’s children have been very nice to John while others have been quite mean to him. Karen has significant wealth and intends to ultimately leave it to her children; however, she wants to provide for John throughout the remainder of his life if he outlives her. To that end, Karen’s estate plan establishes a trust for John that is protected from estate taxes at her death. The income generated on the trust property is paid out to John for his life, with the principal of the property payable to her children at John’s death. However, she grants John a testamentary limited power of appointment over certain company stock held in the trust so that upon his death, he can determine who among Karen’s children will receive that stock and in what shares. Karen explains this to her children so that they get the message that if they mistreat John after she is gone, he has the authority to reduce the value of their share of her trust by at least some degree. Her hope is that this will incentivize her children to treat John with a certain level of respect that they sometimes have struggled with during her life. 

These examples illustrate just a few of the more common reasons why and how powers of appointment can be creatively used to build flexibility into an estate plan. There are many other ways to use these incredibly useful tools. It is important to note, however, that they can also create significant risk and lead to unintended consequences.
 
For example, what if John, in the example above, turned out to be vindictive and, out of spite, exercised his testamentary limited power of appointment to grant everything to one of Karen’s children who had a terrible gambling problem, and who then lost everything in one weekend in Atlantic City? Certainly, this would not have been what Karen had intended. But, a power of appointment can lead to this type of result if the power holder chooses to exercise their power irresponsibly.
 
How Can This Information Help You?
Now that you have a better grasp on the uses and limitations of this powerful estate planning tool, you can better identify in your own circumstances the situations that would call for use of a power of appointment. You can also identify the existence of powers of appointment in your own estate planning documents or in the documents of your loved ones, and consider whether these are in fact appropriate for the circumstances.
 
If you would like to learn more about how powers of appointment can be used to help you achieve your estate planning goals while maintaining significant flexibility in your planning, please do not hesitate to reach out to us. We are eager to help you make the best planning decisions for your unique needs. Give us a call today.

[1] I.R.C. § 2041(b)(1).