Power of appointment: Your estate planning secret weapon

One of the biggest challenges in creating an estate plan is predicting what your family's financial situation will be when you actually pass away. After all, you could create a will or trust today and not die for 40 years, and a lot can change in that period of time. Placing a power of appointment in your will or trust allows you to name a holder, or person with the authority to redirect your inheritance and decide where the money or property will go when you die.

Reasons for power of appointment

The holder can choose to give some or all of your assets to other beneficiaries or descendants, to charities, or to their own children. This builds flexibility into your estate plan so that the holder can decide at the time of your death where the assets should actually go. This could be useful if a beneficiary you chose has a lot of debt when you die and the assets would immediately be seized by creditors. It could also be useful if a beneficiary is quite wealthy at the time of your death and doesn't need the inheritance, making it a better idea to divert the inheritance to a more worthy beneficiary, such as a charity. Note that a power of appointment is different from a power of attorney, which gives someone the authority to make financial decisions for you while you are alive.

Let's say you divide your estate among your children, who are ages two and four when you, the testator, write your will. You can name your spouse as the holder of a power of appointment so that, when you pass away, she can reassess the family's situation and decide if the money should actually go to the children. She may decide, for example, that your grandchildren might benefit from the money more than your children would.

General vs. limited power of appointment

A general power of appointment gives the holder the right to redirect an inheritance anywhere they want, such as to other beneficiaries, their own children, charities, or businesses. There are no limits on where the beneficiary can direct the assets.

In contrast, a limited, or special, power of appointment allows the holder to redirect the trust or estate assets only among a certain group (such as just grandchildren) under certain circumstances. For example, the group could be limited to the testator's descendants or to charities, which could mean the holder could not allocate the assets to their own children or their creditors. Another way a limited power of appointment can be used is to allow the holder to give assets to themselves only if it is for use for the holder's health, education, support, and maintenance.

Tax consequences

Powers of appointment have tax repercussions. If you give your holder a general power of appointment, the assets are included in the holder's taxable estate at their death and they are responsible for gift or estate taxes on the assets, even if they never exercise the power of appointment. The reasoning behind this is that the holder has control of the assets and, as such, has a form of ownership. However, a general power of appointment does allow you to avoid the generation-skipping tax (GST), which is imposed on inheritances that skip a generation, i.e., when you leave something to grandchildren instead of to your children. A limited power of appointment, on the other hand, avoids all gift and estate tax responsibility for the holder.

Powers of appointment are a way to ensure that your estate plan can be adjusted to the beneficiaries' circumstances at the time of your death. If you need help creating a power of appointment, consider using an online service provider.