When making decisions about estate planning, it is necessary to be aware of the various legal tools that are available to carry out your ultimate objectives. Powers of appointment should almost always be a part of the discussion about a person’s will or revocable trust. It likely will also be an important topic to discuss for anyone who has received as an inheritance an interest in or distribution from a will or trust set up by someone else.
In very basic terms, a power of appointment is the authority to decide to whom property is to be transferred, regardless of the intent of the original owner of the property. For instance, say Hank created a trust that provides that on his death his property is to be held in trust for his wife, Willa, while she is alive, and then is to be distributed upon her death to their son, Steve. But Hank suspects that under certain circumstances this distribution could cause more harm than good to Steve, due to Steve’s history of drug use, poor financial decisions, manipulative in-laws, or whatever other reason. Hank decides that after his death, but during Willa’s remaining lifetime, Willa will have the ability (power) to direct (appoint) the trustee to distribute the remaining trust property to anyone else upon her death, which may result in Steve never receiving any portion of the trust.
It is important to divide powers of appointment into two categories: limited powers of appointment and general powers of appointment. This distinction is important not only because it defines the scope of authority the designated holder of the power has, but also because there can be significant estate tax implications.
In cases where the holder can exercise the power for the benefit of any person or entity in the entire world, even himself or herself, the power is referred to as a general power of appointment. The alternative is to “limit” the power of appointment so that the holder can only direct the trustee to distribute the remaining property to certain people, classes of people, or entities. For instance, maybe Hank, in an effort to keep his assets protected from Willa’s present or future creditors, will limit the power he is giving to Willa so that she cannot appoint the property to herself, her creditors, her own estate, or the creditors of her estate. Or perhaps he wants to further narrow the scope of her power by only allowing her to appoint the property to their descendants, so that he knows that if Steve’s not getting the property, at least someone else in the bloodline is.
Whenever a properly drafted will or trust provides for a power of appointment, there will always be a default provision that provides a disposition of the property in the event the holder of the power never exercises it. For example, Hank may want Steve to be the remainder beneficiary in the event Willa does not exercise the power of appointment.
Ultimately, it is important for a person who has inherited an interest in a trust created by someone else to know if they have a power of appointment, to whose benefit they are able to exercise that power, and what the default disposition of the trust will be if they fail to exercise the power. In other words, whether you are in Hank’s situation (drafting your own estate plan) or Willa’s (holding power of appointment over someone else’s property) or Steve’s (remainder beneficiary of a trust), you should seek legal advice from an Arizona Estate Planning Attorney about the implications of a power of appointment.