Filling in the blanks
Powers of appointment add flexibility to your estate plan

One of the biggest challenges of estate planning is deciding how your wealth will be distributed years or even decades later. After all, laws, relationships and personal situations will change over time, affecting your plan’s ability to achieve your goals.

What if circumstances change and you die or become incapacitated before you have a chance to amend your estate plan? Is there a way to build flexibility into it to adapt to these changes? One potential solution is to grant a power of appointment to a trusted family member. It’s like leaving some blanks in your estate plan and designating who gets to fill them in.

How it works

A power of appointment is a legal instrument that authorizes your designee — the “holder” — to decide who will receive certain property held in your estate or in a trust. Powers of appointment can be “general” or “limited.” General powers allow holders to direct the property to anyone, even to themselves, their estates or their creditors.

Holders of limited powers of appointment generally can’t direct the property for their own benefit. Typically, they’re given the authority to decide how and when certain assets will be distributed to a person or class of people. For example, your will might establish a trust for your son and give him the power to distribute the remaining trust assets to his children as he sees fit. He can exercise the power during his life or, more likely, in his own will.

Tax implications

For tax purposes, there’s a critical difference between general and limited powers of appointment: When a person receives a general power of appointment, the property is included in his or her taxable estate. In many cases, however, the resulting estate taxes are outweighed by the generation-skipping transfer (GST) tax savings.

The GST tax is a flat tax, at the highest marginal estate tax rate (currently 45%), imposed in addition to estate tax on certain transfers to your grandchildren or other beneficiaries who are two or more generations younger than you. The GST exemption (currently $2 million) offers some protection, but the combination of estate and GST taxes can quickly devour enormous amounts of wealth.

Granting general powers of appointment to your children allows them to distribute your wealth to your grandchildren without triggering GST taxes. True, this causes the assets to be included in your children’s estates. But, depending on your children’s estate tax situation, the overall tax burden might be less than if you had transferred the assets directly to your grandchildren.

A powerful tool

Under the right circumstances, a power of appointment can add flexibility to your estate plan and generate significant tax savings. Combine it with other strategies, not discussed here, to ensure you’re transferring as much of your wealth as possible to your loved ones rather than to Uncle Sam. •