Powers of Appointment
In setting up a trust or executing a will, the donor generally decides who gets what. However, if the property is put into a trust, the donor can decide to give someone else the power to decide who gets the property, by giving the donee a power of appointment, where the donee can appoint the appointive property, which is the property subject to the appointment, by transferring it to the appointee, who is the receiver of the property and must be a member of the class of permissible appointees, otherwise known as the objects of the appointment power specified in the creating instrument, usually either the donor's will or trust instrument. Not only do powers of appointment increase the donor's flexibility in distributing the trust assets, but they can also lower taxes and limit creditors' remedies against appointees.
Generally, people who receive powers of appointment are expected to live longer than the testator, so they will be in a better position to make a wiser choice of who should receive trust property, how much, and what combination of principal or income should be paid. Powers of appointment are especially beneficial when there are many beneficiaries to a trust or estate.
Additionally, a general power of appointment can be used to avoid generation-skipping transfer taxes. By giving a first-generation beneficiary a general power of appointment, which will be includable in the estate of the beneficiary, the unified tax credit can be used to prevent taxation of the general power. The beneficiary then can transfer the property to 2nd or later generations of the testator without it being subject to the GST tax.
Powers of appointment are often executed by an instrument other than a will, to avoid confusion and to prevent the accidental exercise of the power. It also avoids probate of the property subject to the power. Because the donee does not actually own the appointive property, the property will not be subject to the intestate rules, but will be distributed per the original donor's desires.
A power of appointment is always discretionary and can be given to anyone, but is usually given to a trust beneficiary. Unlike a trustee, who owes a fiduciary duty to the beneficiaries of the trust, the holder of a power of appointment owes no duty to anyone and may choose not to exercise the appointment or even release the power.
Creating a Power of Appointment
The donor must only express an intent to create a power — specific words are not necessary. There may be other requirements in the creating instrument, such as the need to explicitly reference the power when exercising it so that the donee does not exercise the power inadvertently through ambiguous wording.
Powers of appointment are distinguished by whether the donee can be an appointee and when the power can be exercised: inter vivos, testamentary, or either.
General Power of Appointment
A general power of appointment allows the donee to give the subject property to anyone, including herself, her estate, or her creditors. The appointive property may be given outright, placed in a trust, or the power of appointment can be transferred to someone else.
For tax purposes and creditor remedies, the holder of a general power of appointment is considered the owner of the appointive property until she appoints the property to someone else. Therefore, any appointment of property to other beneficiaries may result in a gift tax liability, and if the holder of the general power of appointment dies before exercising it, the appointive property will be included in her estate.
If the donee is permitted to withdraw some of the trust principal, then the power is considered a general power unless the withdrawal is limited by an ascertainable standard based on health, education, or support of the donee.
Special Power of Appointment
A special power of appointment does not allow the donee to appoint the property to herself, her estate, or to her creditors or creditors of her estate.
Under common law, the holder of a special power was expected to exercise it by transferring the property to someone else. However, the modern trend has been to allow the holder to place the appointive property in a trust or to transfer the power of appointment as long as the permissible appointees of the transferred power are the original permissible appointees as determined by the original document creating the power.
A special power is exclusive if it allows the donee to give all the appointive property to 1 or a few members of the objects of the appointment; a holder of a nonexclusive power must give at least some of the property to each permissible appointee, and many jurisdictions require that the minimum distributed to each permissible appointee exceed a token amount.
A donee may not try to appoint property to someone who is not a permissible appointee by making a deal with someone who is — the deal being that if the holder appoints property to the permissible appointee, the appointee will then give some property to the one who is not an object of the power. Otherwise, the court may rule the transference as a fraud and void the entire appointment.
Note that if a limited power is used to provide support for children for which the powerholder has a legal obligation to provide support, then that power will be treated as a general power for estate tax purposes.
The appointive property is considered the property of the donor or the trust until the donee exercises the power by appointing it. To exercise the appointment, the donee must express an intent to exercise the appointment that is in accordance with both the originating document and applicable law.
If the appointive property is real estate, then the applicable law of the state in which the real estate is located is controlling. If the appointive property is personal, then the jurisdictions are split as to whether the state of domicile for the donor or the donee, or the location of the trust is the applicable law.
The donee may be limited by the originating document to exercising the power during the donee's lifetime, by the donee's will, or either, and there may be more specific instructions that must be followed to exercise the power.
A power is exercised when the donee intends to exercise the appointment. As with the creation of the appointment, no specific words are required to exercise, but the intention must be clear.
The donee exercises a lifetime power (aka inter vivos power) by a writing or the execution of a deed, while a testamentary power can only be exercised by the donee's will.
Because the holder of the appointment has no duty to exercise it, most originating documents specify the takers in default, the appointees who will take the appointive property by default if the power is not exercised.
If the donee of a general power dies without exercising it, most courts will consider extrinsic evidence to determine if the appointment should be included in the residuary estate; some courts will consider the appointive property to be part of the residuary estate. Uniform Probate Code (UPC) §2-608 states that a residuary clause expresses the intent to exercise a general power of appointment if the creating instrument of the general power does not have a gift-in-default clause if the power is not exercised or the testator's will indicates that the appointive property is to be included in the estate. Since a gift-in-default clause offers some tax advantages when the power is not exercised, it is often added with the expectation that the donee will not exercise the power.
If the originating document requires a specific reference to the power, then some courts hold that a blanket-exercise clause (aka blending clause), such as wording that places all appointive property into the residue of the estate is not an effective exercise of the power. However, UPC §2-704 comments that the presumption of non-exercise can be overcome if there is evidence that the donee had knowledge of and intended to exercise the power.
If the donee fails to exercise the power, then the disposition of the property may be determined by the donor's intent. If there are takers in default, they will take the appointive property if the appointment is not exercised. However, if there are no takers in default, then the property of a general power reverts to the donor or the donor's estate, then distributed accordingly. If the number of permissible appointees of a special power is small, then the courts may rule that the donor intended that the property be divided and distributed to each permissible appointee.
Rather than exercising, the donee can release her power of appointment, either completely or partially. The release can specify the appointive property, or limit the permissible appointees. A release has the same effect as if the appointment was never exercised, for the donee is asserting that she will never exercise the appointment. Hence, a release has the effect of an appointment that was never exercised, but is fixed at the time of release.
Testamentary Power of Appointment
A testamentary power can only be exercised after the donee's death. This forces the donee to exercise the power through her will, relegating and finalizing the decision until the very end. The purpose of the testamentary power is so that the donee will probably make a wiser decision by allowing the donee to change her mind about the appointment at any time before her death. However, a testamentary power can be released while the donee is still alive.
To conform to the purpose of a testamentary power, a contract to exercise the appointment in a particular way is null and void, but if the contracting party gave considerable value for the contract, then they may be entitled to restitution from the donee for the consideration given. Because the donee has the right to release the power, the courts may enforce a contract if its requirements of the donee are tantamount to a release of the power.
Exercising a Testamentary Power of Appointment
To exercise a testamentary power of appointment without ambiguity requires that the appointment be explicitly referred to in the creating instrument. In most jurisdictions, a residuary clause, without more specific terms, does not exercise a testamentary power of appointment.
A blended residuary clause places appointive property in the residue of the estate, which may raise an issue of intent with respect of whether the testator actually exercised the appointment, which a court may resolve with extrinsic evidence.
The allocation doctrine restrains the donee from combining the appointive property with her own property and ensures that only eligible appointees receive the appointive property.
The capture doctrine holds that where the donor blends her property with the appointive property and 1 or more of the gifts fail, then the failed gift is deemed to have been appointed to the donee and distributed accordingly.
If the appointee has the legally required relationship to the donee to apply lapse or anti-lapse statutes to an appointee who has predeceased the donee, then the statutes will be applied for a general power, but in many jurisdictions, it will not be applied to a special power where the resulting appointee would not be a permissible appointee. However, the modern trend is to apply the statutes to a special power even if the resulting appointee would not be a permissible appointee for the special power. For instance, UPC §2-603(b)(5) states that, unless the donor intended otherwise, the descendant of an deceased appointee can take in place of the deceased appointee, even if the descendant is not a permissible appointee.