What Is a Powers of Appointment Trust?

A power of appointment trust is an estate planning vehicle where the creator gives another person the authority to decide who will ultimately receive the trust’s assets. This mechanism allows an estate plan to adapt to changing family circumstances that may not be foreseeable when the trust is created. The person creating the trust determines the scope of this authority, empowering a trusted individual to make distribution decisions in the future based on the needs of potential beneficiaries. This structure is useful in long-term trusts designed to last for multiple generations.

Core Concepts of a Power of Appointment

A power of appointment involves several key parties and concepts defined within the trust document.

• Donor: The individual who creates the trust and grants the power, establishing the rules and limitations.
• Donee (or Powerholder): The person who receives the authority to “appoint” or distribute the trust’s assets.
• Appointive Property: The specific assets within the trust that the donee has control over.
• Permissible Appointees: The group of individuals or entities to whom the donee can distribute the property.

The donor should also name takers in default, who are the individuals or entities that will receive the property if the donee fails to exercise their power. This provision ensures the donor retains ultimate control over the property’s destination if the donee does not or cannot act.

General vs. Special Powers of Appointment

Powers of appointment are classified into two categories: general and special. A general power of appointment gives the donee the broadest control. Under federal tax law, a power is defined as general if the donee can exercise it in favor of themselves, their estate, their creditors, or the creditors of their estate. This extensive authority allows the donee to treat the trust property as their own for distribution purposes, providing maximum flexibility.

In contrast, a special power of appointment is any power that is not general. With a special power, the donor restricts the donee’s choices, and the donee cannot appoint the property to themselves, their estate, or their creditors. The donor can define the class of permissible appointees narrowly, such as “to my descendants,” or more broadly, such as “to any person or entity other than the donee, their estate, or their creditors.”

A power is not treated as a general power if it is limited by an ascertainable standard relating to the donee’s health, education, maintenance, or support (HEMS). For instance, if a trust allows a donee to withdraw funds for their “health and maintenance,” this is not a general power. If the trust allowed withdrawals for “comfort” or “happiness,” it would likely be considered a general power because those terms are not ascertainable standards.

Taxation of Appointive Property

The tax consequences of a power of appointment are tied to whether the power is general or special, with implications for federal estate and gift taxes.

For a general power of appointment, the law treats the donee as the owner of the appointive property. Under Internal Revenue Code (IRC) Section 2041, the full value of the property is included in the donee’s gross estate for federal estate tax purposes upon their death. This inclusion occurs whether or not the donee actually exercises the power. If the donee exercises or releases the general power during their lifetime, it can trigger federal gift tax consequences under IRC Section 2514.

Property subject to a special power of appointment receives more favorable tax treatment. Because the donee is not considered the owner of the property for tax purposes, the appointive property is not included in the donee’s gross estate at their death. This allows a donor to create a trust for a beneficiary, giving them the power to decide how assets will be distributed among the next generation without causing those assets to be taxed when the beneficiary dies.

Drafting and Administrative Provisions

For a power of appointment to be effective, the trust instrument must be drafted with precision. The document must explicitly grant the power to the donee in a grant of power clause. This clause should define the scope of the authority, specifying whether it is general or special and identifying the permissible appointees.

The trust document should also detail the specific requirements for exercising the power. A donee exercises a power of appointment through a formal written instrument, most commonly a provision in their own will. The trust may require that the donee’s will make a specific reference to the power to ensure its exercise is intentional.

Finally, the trust must include default provisions that name the takers in default. This is a safeguard to direct the property if the donee fails to validly exercise the power for any reason.