Many estate plans today contain trusts that will continue on for the benefit of a spouse’s lifetime and then will continue on for the benefit of several generations. Because these trusts are designed to span several decades, it is important for the grantor (trust creator) to consider including “powers of appointment” in the trust to allow trust beneficiaries to be added or excluded at each generation.
What is a Power of Appointment?
Generally speaking, a power of appointment is a right granted to an individual under the terms of a trust to alter the distributions from that trust.
Powers of appointment can be given to current beneficiaries or trustees of a trust. They can also be given to an outside third party such as a trust protector. Powers of appointment come in many different forms and include powers that can be exercised while the individual is living (a “lifetime” power of appointment), or after the individual dies (such as a power of appointment exercised in the individual’s own will or trust, which is called a “testamentary” power of appointment).
Powers of appointment can be as broad or limited as the trust creator desires. In other words, the trust creator can give the power holder the ability to make broad changes to the trust distributions or to make very limited changes under very limited circumstances.
Examples of How Powers of Appointment Work
Below are some examples of how a power of appointment can be used to change the beneficiaries of a trust:
- The trust creator’s spouse can be given the power to include or exclude children, grandchildren, and other heirs as trust beneficiaries after the spouse dies.
- The trust creator’s child can be given the power to include or exclude the child’s own heirs or the child’s spouse, siblings (brothers and sisters), or heirs of the child’s siblings (nieces and nephews) as trust beneficiaries after the child dies.
- If the trust creator is married but doesn’t have any children, the trust creator’s spouse can be given the power to include or exclude the trust creator’s extended family members and one or more charities as trust beneficiaries after the spouse dies.
These are of course only a few examples; the possibilities are truly endless for how powers of appointment can be used to change the terms of a trust.
Do Not Attempt to Draft Your Own Powers of Appointment
If you are concerned about how your children, grandchildren, or even great grandchildren will eventually grow up, you can build flexibility into your trust by giving your spouse or other beneficiaries the ability to include or exclude heirs through the use of powers of appointment.
Beware: Poorly drafted powers of appointment can create all sorts of gift tax and/or estate tax problems for your trust beneficiaries and trustees. Therefore, powers of appointment should only be drafted or included in a trust with the assistance of an experienced estate planning attorney.
Effect of Powers of Appointment on Estate Tax and Capital Gains
A general power of appointment is a power of appointment that may be exercised in favor of the holder of the power, the holder’s estate, or the creditors of either the power holder or the power holder’s estate. A general power of attorney causes inclusion of the assets subject to the power into the holder’s taxable estate. As a result, the assets subject to the power get a step-up in basis at the death of the holder to the fair market value of the assets as of the date of death of the power holder.
Conversely, a limited power of appointment is a power of appointment that may be exercised in favor of whomever the power holder designates as long as it may not be exercised in favor of the power holder, the power holder’s estate, or the creditors of either the power holder or the power holder’s estate. As such, a limited power of attorney may be exercisable in favor of a very broad class (including millions of people) as long as it may not be exercised in favor of the prohibited groups mentioned above. A limited power of attorney does not cause the assets subject to the limited power to be included in the power holder’s taxable estate and, therefore, does not cause a step-up in basis.
Remember, receiving a step-up in basis will minimize capital gains tax upon the sale of the assets. The tradeoff, however, is that the assets will typically be included in the estate for estate tax purposes. If you would like to discuss how to incorporate powers of appointment into your trust, please call our office today to schedule a free initial consultation.
Zach Wiegand is a Minnesota estate planning attorney and the owner of Gold Leaf Estate Planning, LLC. Gold Leaf Estate Planning is an estate planning law firm that also handles probate and trust administration in Minnesota. We serve the Twin Cities metropolitan area with a focus on estate planning for clients in Burnsville, Eagan, Savage, Prior Lake, Lakeville, Apple Valley, Eden Prairie and the South Metro as well as clients in Woodbury, Lake Elmo, Maplewood, Oakdale, St. Paul and the East Metro. Our firm has offices in both Burnsville and Woodbury (Lake Elmo). The firm also handles probate in Dakota County, Washington County, Scott County, Hennepin County, and Ramsey County and most other counties in the Twin Cities Metro area. Zach has been named a Minnesota Super Lawyer – Rising Star for 2017, 2018, and 2019, and he is a member of WealthCounsel – a national organization of estate planning attorneys dedicated to practice excellence. You can contact Zach via e-mail at firstname.lastname@example.org or by calling (952) 658-6503. Gold Leaf Estate Planning is located in Burnsville at 3000 County Road 42 W., Suite 310, Burnsville, MN 55337 and in Woodbury/Lake Elmo at 8653 Eagle Point Boulevard, Lake Elmo, MN 55042.