Powers of Appointment – An Essential Tool For Building Flexibility Into Your Estate Plan

The ideal estate plan is one that not only satisfies all of a person’s current goals and objectives, but also provides flexibility to allow for changes both during the person’s life, as well as changing circumstances affecting the lives of their children and other loved-ones.  People typically recognize that they can modify wills and revocable trusts at any time.  But they are often surprised to learn that even an irrevocable trust – such as the Medicaid Asset Protection Trust that is commonly used as a Medicaid planning device – can be drafted to allow for changes not only in the choice of beneficiaries, but also the manner in which a beneficiary will receive an inheritance.

The magical planning tool that allows for such flexibility is known as a “power of appointment.”  A power of appointment may be either “general” or “limited” (which is also sometimes referred to as a “special” power of appointment).  A general power of appointment authorizes the power holder to direct the property over which the power is granted to any person or entity.  A limited power of appointment grants the power holder authority to direct the designated property to a more limited class of persons or entities, often limited to the descendants of the person granting the power.

Powers of appointment are typically included in wills and trusts, but can also be incorporated in other legal instruments such as deeds.  Why would someone consider incorporate a power of appointment as part of their estate plan?  Because life happens!  As but one example, one spouse will sometimes outlive the other spouse by many years, and changing circumstances may render the original planning unsatisfactory to the surviving spouse. 

Assume, for example, that in 2007 Sam and Mary met with their attorney to work on their estate planning.  The couple agreed that upon the first spouse’s death the deceased spouse’s assets would be left in a protective trust for the surviving spouse, and after both of their deaths, their combined assets would be divided equally between their two children, Paul and Jennie.  After learning the many benefits of leaving assets in protective trusts for their children, Sam and Mary executed revocable trusts providing that after both of their deaths the couple’s assets were to pass equally into protective trust shares for their children.

Relying on their attorney’s sage advice, Sam and Mary’s revocable trusts included limited powers of appointment authorizing the surviving spouse to leave the deceased spouse’s trust assets among any of their descendants in any manner.  Each trust further provided that the power of appointment would be deemed exercised if the surviving spouse were to include a provision in their will or revocable trust specifically exercising the power.  In essence, each spouse afforded the surviving spouse – whoever that would be – with the “last look” at the family’s circumstances to determine if the equal asset distribution included in the original plan remained desirable.  

Fast forward to 2009 when Sam passed away.  Soon thereafter Paul, who had a seemingly stable life, saw his world fall apart.  He was laid off from his job as an executive at a large company, and at age 53 found himself unemployed for the first time in his adult life.  Six months later, as the tension in his home continued to build, Paul’s wife Sally moved out with their three children and filed for divorce. 

Mary, being distraught over her son’s changing circumstances, called her attorney for advice. While she was helping out Paul with periodic cash gifts to help keep him going, she wondered if she should change the children’s inheritances in light of the changing circumstances. She spoke to Jennie, who told her mother that Mary should feel free to leave a larger inheritance for Paul.   Mary’s attorney told her that not only could she leave more of her own trust assets to Paul’s trust share, but that she could also exercise the power of appointment provided to her under Sam’s trust to make a similar allocation of Sam’s trust assets to Paul’s trust after Mary’s death.  Accordingly, Mary decided to amend her revocable trust to leave 75% of her own trust assets to Paul, and exercised the limited power of appointment granted to her by Sam to leave the same percentage of Sam’s trust assets to Paul.

Another common use of a power of appointment is for a person executing an irrevocable trust to retain for himself the power to modify the beneficiaries under the trust without having to formally amend the trust.  Even if the retained power is never exercised, the mere inclusion of the power in the trust instrument will cause the trust assets to be includable in the trustmaker’s estate, thereby insuring that the trust assets will receive a “step-up” in cost basis for capital gains tax purposes.

In my experience powers of appointment are woefully underutilized, presumably because of a lack of understanding of the many benefits that this legal tool provides.  But any serious estate planning discussion must include a conversation about how powers of appointment may be incorporated into one's estate plan to ensure that the desired objectives can be realized.

Asset Transfer That Rendered Spouse Insolvent Found to Be a Fraudulent Conveyance

Asset transfers inevitably form a part of almost any asset protection plan where Medicaid eligibility is a primary objective. A brand new New York decision provides a cautionary tale that too much of a good thing may be a bad thing.

On June 9, 2011, the New York State Supreme Court, Appellate Division for the Third Judicial Department, rendered a decision in Matter of Steele. After Mrs. Steele entered a nursing home in July 1998, Mr. Steele filed a "spousal refusal" letter, which excluded Mr. Steele's income and assets from the determination of Mrs. Steele's Medicaid eligibility.  Mrs. Steele received Medicaid coverage for approximately three years prior to her husband's death.  After Mr. Steele died in November 2001, the Saratoga County Department of Social Services ("DSS") brought a recovery action against Mr. Steele's estate, seeking reimbursement towards Medicaid paid by the County for Mrs. Steele's care.

At the time of his death, Mr. Steele relatively few assets.  Years before his death he had purchased an annuity (it is unclear if payments had terminated at the time of his death), and had transfered a summer camp to his children for no consideration, retaining a life estate in the deed of conveyance.  Finally, just before his death, Mr. Steele transferred his car to his caregiver.

It was this final -- and seeminly innocuous -- transfer of the autmobile that ends up as the determining factor.  Among it's many claims, the Saratoga County  DSS contended that Mr. Steele's purchase of the annuity, transfer of the remainder interest in the summer camp, and gift of his car rendered him insolvent and thus constituted a "fraudulent conveyance" under New York's Debtor and Creditor Law.  The court ruled that the purchase of the annuity was for consideration (which it was), and the conveyance of the real estate did not render Mr. Steele insolvent.  The court ruled, however, that the gift of the car did render Mr. Steele insolvent, since upon transferring the vehicle his liability  exceeded his resources by approximately $1,700, and thus did constitute a fraudulent conveyance.  As a result, the court held that the Saratoga County DSS was entitled to recover Mr. Steele's "available resources" at the time of the original Medicaid filing in 1998, plus his "excess income" for the 39 month period between Mrs. Steele's entry into the nursing home and Mr. Steele's date of death.

The implication of this case is that had Mr. Steele retained the car -- and thus remained "solvent' at the time of his death -- DSS would not have prevailed on its fraudulent conveyance claim and would have been entitled to no recovery against his estate. 

This moral of the story: engaging in a planned strategy of asset transfers has been, and likely will continue to be, a key to protecting assets when faced with long-term care cost; however, trying to save every penny will likely backfire under the theory, "pigs get fat, hogs get slaughtered!"

Estate Planning for a Terminally Ill Client

People often ask, “When should I do my estate planning?” My tongue-in-cheek reply is, “Call me six months before you know you’re going to die, and we’ll take care of it then.”  People get the point that there is generally no “right” time to do their estate planning, but they should address the issue sooner rather than “too late.”

There are those unfortunate occasions when a person in fact learns that they have a short time to live because of a terminal condition.  While some planning strategies will be unavailable for someone having a terminal illness – for example, the terminal client will be unable to purchase life insurance – many other options remain available to achieve the client’s planning goals.

I recently met with a couple in their 60’s, who I’ll call “Mr. and Mrs. Roberts.”  Mr. Roberts was recently informed that the cancer he has been battling is no longer treatable.  Mrs. Roberts has chronic health issues, but is likely to live for many years.  Their total estate value is approximately $2.5 million, with about half of that amount in the form of two IRA’s of approximately equal value owned by Mr. Roberts.  Under their existing estate plan, all assets would pass directly to the surviving spouse (presumably Mrs. Roberts).

The main planning challenges are:  (1) to protect the Roberts’ assets in the event that Mrs. Roberts needs long-term care, and (2) to minimize estate taxes.  These two objectives are somewhat in conflict, because to achieve estate tax savings, we would typically transfer to each spouse’s name at least $1 million of their assets so that each spouse could take advantage of the full $1 million New York estate tax exemption upon their deaths. However, putting assets directly in Mrs. Roberts’ name would likely provide fewer protections for the assets than if they were to pass under Mr. Roberts’ will into a  “supplemental needs trust” established for Mrs. Roberts’ benefit.  Under federal and New York law, assets passing to a surviving spouse in a supplemental needs trust created under a will are deemed “exempt” for determining a surviving spouse’s eligibility for Medicaid long-term care benefits.

While we are just beginning planning for the Roberts, we discussed a few options at our initial meeting.  One idea is to name their two children as the beneficiaries of one of the IRA’s (worth about $650,000), since it appears Mrs. Roberts can live comfortably without it.  She would remain the beneficiary of Mr. Roberts’ other IRA, which is worth approximately the same amount.  We will likely recommend using “retirement plan trusts” for each child, which will allow each child to take the required minimum distributions (“RMD’s”) over their own individual life expectancies.  These “stretched out” IRA distributions will result in significantly more income tax deferral.  An additional benefit to the retirement plan trusts is that the RMD’s will be distributed to creditor-protected trusts for each child.

We will also likely recommend that certain assets (i.e., the residence) be transferred to Mr. Roberts’ name only.  Upon his death, those assets will be funded into a discretionary supplemental needs trust for Mrs. Roberts’ benefit, and under current law will be considered “exempt” assets for Medicaid purposes without a five-year “look back period.”  In doing so, we will have to evaluate the estate tax implications of the asset funding.

The plan will surely evolve as we and the Roberts’ engage in more in-depth discussions to fine-tune their goals and objectives.  However, the bottom line is that planning for a seriously ill client requires consideration of all the potential outcomes, and the final plan should be designed to ensure maximum flexibility to address changing circumstances.