One of the significant advantages of utilizing a trust in estate planning is that it allows flexibility in distribution of assets even after the death of the Settlor who created the trust. Thus, if one has two children and wishes to give an equal inheritance to each, but an unanticipated event occurs after your death which requires additional help to one of the children (an accident causing permanent damage; long term illness of that child, etc.) the trust can instruct the trustees to adjust the giving to take into account the newly arising remarkable needs of one of the beneficiaries.
This flexibility includes protecting the assets from the claims of third parties, be it creditors or ex spouses, etc. By instructing the Trustee to withhold distributions until the third party claim is extinguished, the beneficiary can be protected.
That same type of flexibility, though in a more limited sense, may be created by use of Powers of Appointment which allows an appointed person to elect who is to receive a distribution at a later time. The basic law and practical use of such powers are discussed in this article.
The Basic Law:
A power of appointment is a power to dispose of property. The power can be as broad or limited as the creator desires depending on whether the creator chooses to give general power of appointment or special powers of appointment. A power of appointment can also be presently exercised or postponed until a specified event occurs or a condition is met.
According to Black Law’s Dictionary ( 5th Ed.), the definition of a power of appointment is, “ a power or authority conferred upon one person by deed or will upon another (called the “donee”) to appoint….the person or persons who are to receive and enjoy an estate or an income therefrom or from a fund, after the testator’s death, or the donee’s death, or after the termination of an existing right of interest.”
California Probate Code Section 610 (d) defines the donee as, “the person to whom a power of appointment is given or in whose favor a power of appointment is reserved.” The donor, according to Probate Code § 610 (e) is the, “person who creates or reserves a power of appointment.” The appointee is the person in whose favor a power of appointment is exercised (Probate Code § 610(a)) and the appointive property means the property or interest in property that is the subject of the power of appointment (Prob C § 610(b)).
Powers of appointment should not be confused with powers of attorney, which appoint another person to act for you, or durable powers of attorney, which are also a useful estate planning device. Durable powers of attorney are powers of attorney that normally arise only if a person is incapable of making his or her own decision and are a useful tool to provide for medical care or care of assets if one is incapacitated. The standard power of appointment is usually for the benefit of a third party, is not dependent on incapacity of the Settlor, and has different criteria for creation and enforcement. See our article on Wills and Trusts for a fuller description of durable powers of attorney.
Types of Powers of Appointment:
A power of appointment can be either “presently exercisable” at the time in question to the extent that an irrevocable appointment can be made or it can be “not presently exercisable” if it is postponed.
A power of appointment can be postponed according to Probate Code § 612(c) in the following circumstances: “(1) the creating instrument provides that the power of appointment may be exercised only after a specified act or event occurs or a specified condition is met, and the act or event has not occurred or the condition has not been met. (2) the creating instrument provides that an exercise of the power of appointment is revocable until a specified act or event occurs or a specified condition is met, and the act or event has not occurred or the condition has not been met.”
The donor can choose to create a general power of appointment which is defined in Prob C § 611(b) as a power, “exercisable in favor of the donee, the donee’s estate, the donee’s creditors, or creditors of the donee’s estate, whether or not it is exercisable in favor of others.”
A “power of appointment that is not “general” is “special.” (Prob C § 611(d)) Reg. § 20.2041-1(c)(1) states “a power of appointment is not a general power if by its terms it is either – (a) exercisable only in favor of one or more designated persons or classes other than the decedent or his creditors, or the decedent’s estate or the creditors of his estate, or (b) expressly not exercisable in favor of the decedent or his creditors, or the decedent’s estate or the creditors of his estate.”
A special power of appointment cannot be exercised in the donee’s favor. Therefore, a power to appoint anyone other than the donee, the donee’s estate, the donee’s creditors, or the creditors of the estate is special power of appointment.
A power of appointment by a will generally is considered to be created on the day of the testator’s death and is a power created by the Will of the deceased. A power of appointment created by inter vivos instrument (a document created specifically for the establishment of the power or the power is contained in a trust) is considered to be created on the date on which the instrument takes effect. (Reg. § 20.2041-1(e))
The power must be in writing and must be specific in its terms and description. It is advisable to obtain competent legal and accounting advice before creating such a long lasting documents. Consider: if the power is contained in a trust and vests in the children or grandchildren of the creator, it could easily only become effective in twenty or thirty years…perhaps more. By that time, the wishes of the creator may no longer be possible to obtain due to death. It is thus vital to word the power with clarity and precision.
One client put it well. Looking over the massive changes in the world and in her own family over the previous five years while considering her estate plan, she stated, “The world doesn’t stop moving just because I die. I need to find a way to move my gifting around to take that into account even if I am not here. Otherwise, how can I protect my grandchildren in the right way?” At the time she was considering the traumatic effect of the economic collapse of 2008 upon her children who were long unemployed and no longer capable of providing college tuition to their children, but the lesson is clear: if you want to adjust what happens with your wealth after you are no longer able to do it yourself, you need to use a Trust or a power of appointment or both.
Most powers of appointment are contained in Wills and allow a person to alter the gifting within a small class of people, taking into account events occurring after the death of the testator. Typically, the power states the person holding the power may adjust what goes to the children or grandchildren taking into account certain subsequent events, but limits the gifting to only the children and grandchildren and often limits the amount of the change allowed, e.g. only half of a person’s share may be altered, etc.
A Trust allows much more flexibility in creating criteria and allowing appropriate powers to the trustees to alter the mix, but such powers can also be contained in the trust instrument itself. And for those not wishing to draft a trust, the power of appointment, in a limited way, can achieve much of the same flexibility.
There can be tax ramifications in the creation of power of appointments, depending on their vesting schedule, the amounts at issue, and the income and estate tax regime that then exists. Using competent legal and tax experts is a good idea and one should update existing powers if the various laws or taxing regimes have altered.
In the arsenal of tools available to the sophisticated person for estate and family care planning, powers of appointment are a relatively simple method to achieve limited but useful flexibility to adjust to events and circumstances altering after the death of the Settlor. While not as effective to achieve flexibility as a trust, they do allow a method to alter distribution predicated on criteria that can be imposed by the Settlor.