Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company1 What is a Power of Appointment? A right given in a will, trust, or other instrument by one person (donor) to another (donee/holder) allowing the holder to name the recipient (appointee) of the donor’s property at some future time It’s the right to dispose of someone else’s property

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company2 When is a Power of Appointment Used? When flexibility, avoidance of family conflict, and tax-savings are considerations When estate owner would like another person to decide: –Who should receive trust property –How much income or principal should be allocated to any given individual –When principal or income should be paid out When estate owner does not know what the future needs of intended beneficiaries will be or how many beneficiaries he will have

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company3 When is a Power of Appointment Used? (cont’d) When an estate owner desires to qualify assets for the marital deduction and still maintain the right to designate who will receive the property if the spouse does not exercise the power –Power of Appointment vs. QTIP Trust When assets in trust would otherwise be subject to generation-skipping transfer tax upon a taxable termination of the trust Annual exclusion Crummey withdrawal right

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company4 Requirements No “magic” words or phrases required Examine whether words used in a will or trust manifest an intent to create a power –Power to invade or consume trust corpus = power of appointment –Power to affect beneficial enjoyment through altering, amending, revoking, or terminating a trust = power of appointment

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company5 Exercise of Power Specific language used in will exercising the power of appointment –Testamentary power: exercisable only by will at holder’s death Holder mentions powers as part of a general devise or bequest Unintended exercise in residuary clause –General reference to powers of appointment –Consider requiring exercise of power by a separate document other than a will

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company6 Release vs. Lapse Release: formal statement that holder is giving up power Lapse: termination of a power without exercise Note: Exercise, lapse, or release may have tax consequences

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company7 Tax implications General Power: No restrictions on powerholder’s choice of appointees –Powerholder may appoint property to himself, his creditors, his estate, or the creditors of his estate Includes satisfaction of legal obligations of powerholder Includes withdrawal powers Exceptions –De minimis $5,000 or 5% lapse of power –Power exercisable only with consent of creator of power or person with adverse interest Person who will lose something if power is exercised –Power limited to ascertainable standard for health, education, maintenance, or support of the powerholder (HEMS)

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company8 Tax Implications (cont’d) Special or Limited: Powers with certain restrictions –In general, a power other than a general power –Power to appoint to anyone other than powerholder, his creditors, his estate, or the creditors of his estate –For example, power to appoint among children of powerholder

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company9 Tax Implications (cont’d) Income Tax –Powerholder with general power may be treated as owner of all or part of trust No de minimis $5,000 or 5% lapse of power exception Estate Tax –Property subject to general power includable in estate –Property subject to limited power not includable in estate unless power exercised in such manner that transferred property would have been includable in powerholder’s estate if powerholder had been owner (e.g., retained life estate)

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company10 Tax Implications (cont’d) Gift Tax –Lifetime exercise of general power is gift if exercised in favor of someone other than powerholder – A release or lapse of general power is gift De minimis $5,000 or 5% lapse of power exception –Can disclaim a power of appointment Generation-Skipping Transfer Tax –Exercise, release, or lapse of general power is subject to GST tax De minimis $5,000 or 5% lapse of power exception

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company11 5 or 5 Power De minimis rule: The lapse of a general power of appointment is not treated as a release of the power to the extent of the greater of : –$5,000 or –5% of the total value of the fund subject to the power as valued at the time of lapse

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company12 5 or 5 Power (cont’d) Stated another way: To the extent that a lapse of a general power within a calendar year exceeds the greater of $5,000 or 5% of the assets subject to the power, the excess is treated as a release of general power and taxed accordingly Note: To ensure limits are not breached, the right of invasion must be made noncumulative

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company13 5 or 5 Power (cont’d) Example: Jamie Gordon was the income beneficiary of a trust with assets of $80,000. She had a noncumulative power to withdraw $10,000 of principal each year, which she did not exercise. At the expiration of each year Jamie is deemed to have released a general power to the extent of $5,000. Lapse $10,000 minus- $ 5,000 (the greater of $5,000 or 5%) Release $ 5,000 Note: 5% of $80,000 trust assets = $4,000

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company14 Community Property A community property agreement may cause both spouses to have a ½ undivided interest in a power of appointment, resulting in a gift –No federal gift tax, unlimited marital deduction –Check state gift tax rules Special or limited powers may grant each spouse an undivided interest without any gift involvement

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company15 Rules Against Perpetuities The measuring period under the rule against perpetuities relates back to the creation of the power –21 years and nine months from the lives in being at the time the power was created –The power is void unless it must vest within the appropriate period –In some states, the interest will be valid unless it does not actually vest within the appropriate period

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company16 Hanging Power Cumulative power in the beneficiary to appoint any lapsed property in excess of $5,000 per year by will at death Avoids lapse of excess amount by permitting the holder to exercise it in the future

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company17 Hanging Power (cont’d) Withdrawal power up to the 5 or 5 limitation lapses in any given year. The excess withdrawal power is carried over to future years. In future years the carried-over withdrawals are lapsed to the extent of the 5 or 5 ceiling. Unresolved problems in use – withdrawals can be sizable – unused withdrawals included in estate tax – if use life insurance, premiums paid through life of policy

Power of Appointment Chapter 10 Tools & Techniques of Estate Planning Copyright 2011, The National Underwriter Company18 Hanging Power (cont’d) Example: Withdrawal YearGiftPowersLapses 2009$13,000$13,000$5, $13,000$21,000$5, $0$16,000$5, $0$11,000$5, $0$6,000$1, $0$1,000$0 2015$0$0$0