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.

Estate Planning Comes to Hollywood

As discussed in this excellent article in Forbes, the Oscar-nominated film The Descendents, starring George Clooney, is replete with estate planning-related issues.  While I thought the movie was overrated, I did think the film makers did a good job in their handling of such concepts as the need for a living will to handle end-of-life care; the complexity of intra-family relations  as it pertains to real property held in a long-term trust; the common law requirement that requires termination of a trust under the Rule Against Perpetuities;  and how best to pass an inheritance to a child in a manner that will not impair his or her incentive to be a productive citizen (also known as the condition of "affluenza"). 

I am pleased that the producers consulted with a law professor who teaches estate planning to ensure that the estate planning issues were handled appropriately.

When Failing To Do Any Estate Planning REALLY Hurts

Last Friday afternoon I had the good fortune of playing golf on a glorious day with members of a local accounting firm. When I stopped into the office on Saturday  to check my messages and mail (with son and dog in tow), I had a rather desperate voice mail from a woman who was calling on behalf of her aunt.  When I returned the call, this young woman -- I'll call her "Anna" -- explained  that her aunt "Susan" had lived with a man for 33 years who passed away last week, but they had never gotten married and Anna's "uncle Ralph" never executed a will.  Anna said that the couple had attempted to get married but Ralph's condition deteriorated too quickly to permit the wedding to take place.

Anna was understandably concerned for her aunt's well-being, and she asked me what rights Susan has under New York law regarding Ralph's estate.  I asked Anna how Ralph and Susan's assets were titled, hoping that most of their assets were titled as joint tenants with rights of survivorship.  Unfortunately, Ralph has a number of assets in his name only, including the house where he and Susan had lived for many years.

I told Anna that New York, unlike many states, does not recognize "common law" marriage, except in the limited circumstance where a couple represented themselves to be husband and wife in another state that does recognize common law marriage.  About 20-years ago I was involved in just such a case, where a couple in a long-term relationship had traveled to Pennsylvania and registered in a hotel as "Mr. and Mrs. Robert Jones."  Since Pennsylvania does recognize common law marriage, we were able to convince the Sullivan County Surrogate that "Mrs. Jones" was entitled to spousal rights under New York law.  I explained to Anna that unless her Aunt Susan were to be able to present similar proof, she would be entitled to none of Ralph's assets.  Under such a scenario, all of Ralph's assets would pass to Ralph's children (who are not Susan's) children. 

Since Anna told me that Susan does not get along with Ralph's children, I had the sad duty to inform her that Susan might be at risk for being evicted from the home that she has lived in for many years.  To avoid such a result, Susan might be able to show that she contributed to the expenses and maintenance of the home for during her residency, and thus in fact has a reasonable claim to an equity interest in the home.

Unfortunately, all of Susan's options fall under the guise of "hopefully" or "maybe".  All of this could have been avoided had Ralph executed even a rudimentary estate plan consisting of a simple will that designated Susan as the beneficiary of the bulk of his estate, especially the home. 

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.

Estate Planning for Blended Families

In 2010, “blended” families became the predominant family form in the United States.  Couples in such relationship are often conflicted with the desire to not only provide for the needs of the surviving spouse upon the first death, but also to ensure that their own children receive their “rightful” inheritance. 

Unfortunately, too often the estate planning done by remarried couples consists of simple “I love you” wills that provide that all the couple’s assets pass to the surviving spouse.  Not only does such a disposition forfeit a number of planning advantages – including preserving each spouse’s estate tax exemption, protecting assets from creditors and from a potential remarriage of the surviving spouse – but under this scenario, the first spouse to die (the “Deceased Spouse”) would have no assurance that upon the remaining spouse’s death, the surviving spouse (“Surviving Spouse”) will in fact leave the assets of the Deceased Spouse to that spouse’s children. 

A better solution is for each spouse to establish one or more trusts to hold their assets upon their respective deaths.  Upon the Deceased Spouse’s death, his or her estate plan may provide that all or a portion of his or her trust assets passes to a “Marital Trust” for the benefit of the Surviving Spouse.  The Marital Trust would provide income from the trust to the Surviving Spouse for life, and may provide distributions of principal to or for the benefit of the surviving spouse at the Trustee’s discretion. Upon the Surviving Spouse’s death, the trust assets would be distributed to the children of the Deceased Spouse, either outright or preferably in a creditor-protected trust.  One caveat is that the assets in the Marital Trust would be taxable in the estate of the Surviving Spouse; it is critical that the trust instrument provide that the estate taxes, if any, attributed to the Marital Trust assets be payable by the appropriate parties (typically the Deceased Spouse’s children).

If there is a concern that the children of the Deceased Spouse may have to wait too long to receive their inheritance, a portion of the Deceased Spouse’s assets may go directly to his or her children upon death, either outright or in trust.  In 2011, the first $1,000,000 distributed to anyone other than a Surviving Spouse will be exempt from both Federal and New York State estate tax.

Trustee selection is critical in these cases.  Due to the inherent conflict, it is poor practice to have the Deceased Spouse’s children serve as Trustee of the Marital Trust for the Surviving Spouse.  A better choice is typically a professional trustee such as a trust department of a bank or other financial institutions.  Regardless of Trustee selection, it is important that the Marital Trust include explicit instructions describing the circumstances, if any, when the Trustee may provide trust principal to or for the benefit of the Surviving Spouse.

One final piece of “blended” family planning is the need for each spouse to sign a waiver of their spousal right of election.  In the absence of such waivers, the Surviving Spouse would be able to upend the couple’s planning by simply asserting his or her right to the statutory share of the Deceased Spouse’s assets – which in most states is at least one-third of the Deceased Spouse’s assets, and often more.

News Alert -- Upcoming Radio Interview

On Wedenesday, October 6 at 7:00 p.m. ET, I will be interviewed by WTBQ radio's Teddy Smith about current issues in estate planning.  Orange County residents can tune in to 1110 AM, or 99.1 FM.  WTBQ also streams at http://www.wtbq.com/.

I hope you will be able to listen-in!

Don't Wait Until Congress Acts to Work on Your Estate Planning!

Are you waiting until Congress enacts a "permanent" federal estate tax to do your estate planning?  This article points out many (but by no means all) of the reasons why estate planning is so much more than just estate tax planning.

Wisdom During Trying Times

I never knew Rob Jaffee, but he appears to have been the type of client any estate planning attorney would enjoy working with. As described in this article written by Rob's brother, Chuck Jaffee, Rob had the wisdom to convince his reluctant wife to meet with an estate planning attorney to design and implement their estate plan. Two years later, Rob died at 57 just weeks after being diagnosed with a rare disease.

I was moved by these comments Rob made to his brother as the end came near:

Eileen [Rob's wife] didn't want to go meet the lawyers and set everything up, because it was focusing on death and dying at a time when everything was good and happy. But focusing on death and dying while you are living, that's easy; having to focus on death when you are dying, that would be unimaginable. ... Tell people not to let that happen.

People often ask me, "when is it the right time to 'do' my estate plan?"  My standard (and somewhat flip) response:  "six months before you know your going to die, give me a call and we'll get to work."  Coming from an estate planning attorney, my recommendation that people get their estate planning done now may come off as self-serving.  But perhaps reading Rob Jaffee's profound thoughts of the benefit to he and his family of putting together an estate plan before a crisis struck will strike a chord with some people who know they need to do an estate plan, but always find an excuse not to find the time. 

Fun and Games with Gary Coleman's Estate

It is reported that the late actor Gary Coleman executed a 2005 will that would supersede the 1999 will that has already been submitted for probate in a Utah court. Neither Coleman's parents nor his ex-wife (who claims she and Coleman were still married under common law marriage at the time of his death) are named as beneficiaries or executors under the will.

I have no idea what type of estate Coleman might have had at his death, but it seems a lot of people are awfully interested in the proceedings.

Stay tuned for updates.

Avoiding Chaos When the "Glue" is Gone

All too often people have a "blind spot" when it comes to assessing the relationships among their children and other close family members. When I meet with clients to discuss their estate planning goals and objectives, in many instances they take the "just leave all the property equally to the kids and everything will work out" approach.

But as pointed out here, the children may only "play nice" as long as at least one of the parents is living. Once the parents have died, the family "glue" breaks down, and in all too many cases the knives may come out.

While the kids may surely fight about the money and other financial assets, as the linked article points out, it is with the personal property that a lot of the serious warfare occurs. After all, a bank account can be divided; the grandfather clock cannot.

In creating an estate plan, it is essential that serious discussion take place between you and your attorney regarding the disposition of personal effects. The wisest course of action is to specifically designate in a will, trust, or personal property memorandum which items of the significant tangible personal property -- both in a monetary and sentimental sense -- goes to which beneficiary.