Power of Appointment for a Trust or Will

A power of appointment is an estate planning tool that allows one person to decide who ultimately receives certain property, typically from a trust or under a will. The person creating the power can specify who may exercise it, which assets it covers and who may receive those assets. Depending on how the power is structured, it can give beneficiaries flexibility to respond to changing family circumstances, financial needs or tax considerations. However, general and limited powers of appointment provide different levels of control and can have different estate and gift tax consequences.

A financial advisor can help you consider how trusts and other estate planning strategies fit into your broader financial plan.

What Is a Power of Appointment?

A power of appointment is an ability a grantee or beneficiary receives from the grantor or creator of a trust. The power of appointment allows the beneficiary to change a trust in specific ways in specific contexts. For example, a grandparent might place his or her assets in a trust and give their grandchildren the power of appointment over the trust once the grandparent passes away.

In addition, a power of appointment affects irrevocable trusts – which, as the name implies, are not easy to change. Fortunately, a power of appointment means beneficiaries can modify a trust within the boundaries the trust’s creator sets.

General vs. Limited Power of Appointment: Key Differences

Powers of appointment generally fall into two categories: general and limited, sometimes called special powers of appointment. The main difference is how much control the holder has over where the property can go. A general power provides broader authority and can also have more significant estate and gift tax consequences, while a limited power restricts the people or organizations that may receive the assets.

Feature	General Power of Appointment	Limited Power of Appointment
Level of control	Gives the holder broad authority over who may receive the property	Limits the holder to a defined group of possible recipients
Who can receive property?	May generally include the holder, the holder’s estate, the holder’s creditors or creditors of the holder’s estate	Typically excludes the holder, their estate and their creditors and limits appointments to beneficiaries specified by the person who created the power
Estate tax treatment	Property subject to the power may be included in the holder’s taxable estate	Generally does not cause the property to be included in the holder’s estate solely because of the power
Gift tax considerations	Exercising or releasing the power can potentially have gift tax consequences	Generally provides more limited gift tax exposure, depending on how the power is exercised
Creditor considerations	Broader control may increase exposure to creditor claims, depending on applicable law	Typically offers greater separation between the holder and the property
Common use	Provides maximum flexibility over future distributions	Allows flexibility while preserving restrictions established by the grantor
Example	A trust beneficiary can appoint trust assets to themselves, their estate or other beneficiaries	A beneficiary can redirect assets among their children or grandchildren but cannot appoint the assets to themselves

A limited power of appointment can be particularly useful when the person creating the trust wants to give a beneficiary flexibility without turning over unrestricted control. For example, a parent could allow an adult child to divide trust assets among that child’s descendants based on their future financial needs while preventing the child from transferring the property to themselves.

A general power, by comparison, can provide substantially more control. That flexibility can be useful in some estate plans, but it may also cause the property subject to the power to be treated as part of the holder’s estate for federal estate tax purposes. For this reason, the type of power granted can affect not only who ultimately receives the assets but also the tax and creditor implications of the estate plan.

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Types of Powers of Appointment

There are two types of powers of appointment: general and limited. General power of appointment allows the appointed individual to change and direct the trust however he or she wishes. In essence, a general power of appointment gives over complete control of the trust, and the person who has that power can allocate the trust’s assets how that person sees fit.

On the other hand, a limited or special power of appointment has boundaries the holders must follow.

Powers of Appointment and Ownership

A mother and daughter discussing power of appointment for a trust or will.

Depending on appointment type and state law, powers of appointment have varying effects on ownership. For example, your state’s laws may allow you to immediately own property within the trust as the holder of a general power of appointment. However, such ownership also exposes the property to your creditors.

Therefore, if you’re in debt or serious financial trouble, the ownership you receive through a power of appointment could mean losing the property altogether. That said, state law may prohibit creditors from seizing the property until the power holder dies. On the other hand, a limited power of appointment typically doesn’t grant property ownership.

Power of Appointment Tax Treatment

A power of appointment can affect your tax circumstances, even if you don’t exercise the power. Specifically, tax law declares that a general power of appointment designated after Oct. 21, 1942, will add the related trust’s value to the power holder’s estate upon that person’s death. As a result, a general power of appointment usually exposes a trust to federal estate taxes.

In contrast, a limited power of appointment doesn’t create tax implications. The exception to this rule is if the power holder creates another power of appointment granting themselves greater control of the trust.

In addition, a general power of appointment creates gift tax implications. Specifically, unless the transferred property from a trust is less than $5,000 or 5% (whichever is higher) of the trust’s total value, the government will apply the gift tax to said property.

Income taxes also come into play with a general power of appointment. If the trust becomes part of the power holder’s estate, the power holder’s death triggers a reassessment of the trust’s property. If the property appreciates, it steps up to the current market value. On the other hand, if it depreciates, it steps down to a lower value.

Lastly, if a power of appointment enables the beneficiary to take the property, they may receive income taxes according to its value.

Powers of Appointment Key Considerations

While there are a number of factors to evaluate as you make decisions about power of appointment, there are three that are particularly important.

Creating Boundaries in Volatile Situations

Let’s say we have a husband and wife with three children together. The husband dies and leaves his estate to his wife with a limited power of appointment. The wife will receive income from the trust while she is alive, and the trust will be split three ways to the children after she passes away.

Unfortunately, the youngest child has been hiding a gambling addiction that only comes to light after their father passes away. So the mother uses her limited power of appointment to amend the trust’s conditions. She changes the trust so it will pay for the youngest’s child’s basic needs and addiction recovery.

In addition, she creates a limited power of appointment for her oldest child to continue managing the trust after she is gone. This way, she preserves the trust’s stability and ensures the youngest child won’t squander the wealth.

Planning for Disability

With the same scenario in mind, let’s say the middle child has a child with a disability, and will need continuous support from paid caregivers. The trust can provide for some of the grandchild’s needs, but a transfer of wealth could disqualify him from governmental assistance.

As a result, the grandmother structures the trust so it pays solely for what government assistance doesn’t cover. Plus, she modifies the trust to continue paying for non-covered care, items, etc., after she passes away. Lastly, she specifies who will gain the power of appointment if more grandchildren are born later.

Allocating Wealth for Grandchildren

Continuing with the example, let’s say the oldest child is a high-net-worth individual who doesn’t need wealth from the trust. In fact, receiving money from the trust would only cause hefty tax rates because the oldest child is in the highest tax bracket.

Additionally, the oldest child has two children after the first grandchild arrives. Therefore, the mother modifies the trust to split the oldest child’s portion for the two grandchildren instead.

Tax Planning Considerations

Fortunately, a limited power of appointment can direct property worth just under the limit to follow tax exemption laws. In addition, it can prioritize transferring assets with the highest capital gains to transfer them while incurring no taxes. You may need to designate a trustee to carry out the calculations necessary to make these allocations possible.

Bottom Line

A woman and her estate planner discussing power of appointment for a trust or will.

A power of appointment can add flexibility to an estate plan by allowing a designated person to determine how certain trust or estate assets are ultimately distributed. A general power of appointment typically gives the holder broader authority, while a limited power restricts who can receive the property or how the power may be exercised. Those differences can also affect estate and gift taxes, creditor exposure and how assets pass to future beneficiaries. Because the governing document and applicable state and federal laws determine how a power works, careful drafting is important when incorporating one into a trust or will.

Estate Planning Tips

A power of appointment is a complex financial tool that must follow state laws to be effective. A financial advisor can help you ensure the power of appointment will have the desired effect after you pass away. Luckily, finding the right financial advisor doesn’t have to be hard. If you don’t have a financial advisor yet, finding one doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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