When Is A Power of Appointment Used?

Generally a power of apointment is used in estate planning.  For example, a donor may want to give authority to a fiduciary/donee to apoint assets in the fiduciary/donee's discretion to an incapacitated beneficiary.  A power of appointment can be included in a power of attorney, a will, or a trust.  Where a donor does not want to give a fiduciary a power of appointment, it is important to make that desire clear in estate planning documents in order to avoid an IRA argument that the assets the fiduciary is simply managing as a fiduciary are actually part of the fiduciary's estate for estate or gift tax purposes.

Power of Appointment Types

There are two types of powers of appointment:  a general power of appointment and a limited (special) power of appointment.  Each of these types of powers carries different and significant tax implications.

General Power of Appointment:
In a general power of appointment the donor gives the donee authority to appoint (transfer) the donor's rights, assets, or items to anyone the donee wishes, including the donee himself.  Potential adverse tax consequences accrue to a donee who possesses a general power of appointment: the rights, assets, or items which the donee has power to appoint are considered the donee's property for gift and estate tax purposes.

Limited (Special) Power of Appointment:
In a limited (special) power of appointment the donor limits the donee's authority to appoint (transfer) the donor's rights, assets, or items.  The authority may be limited in various ways.  For example, the donee may be limited in regard the the persons to whom he or she can appoint assets; or the donee may be limited in regard to the times at which he or she can appoint assets; or the donee may be limited in regard to the purposes for which he or she can appoint assets (for instance, the health, education, maintenance, or support of the appointee).  In certain circumstances the donee possessing a limited power of appointment and the appointee may be the same person.  With a limited (special) power of appointment, the Internal Revenue Service usually does not consider the rights, assets, or items subject to appointment to be owned by the donee in determining the donee's own gift and estate taxes.  In estate planning, generally a limited (special) power of appointment is preferred over a general power of appointment.

Power of Appointment

Parties involved with a power of appointment are:
"Donor" is the person who creates a power of appointment.  The donor is usually the owner of rights, assets, or items being ultimately appointed by the donee.
"Donee" or "holder" refers to the person who possesses a power of appointment--who has been named to appoint or transfer all or a portion of an owner's rights, assets, or items.
"Appointee" is the person who receives the rights, assets, or items as a result of the power of appointment being exercised.
"Taker in Default" is the person who receives the rights, assets, or items if the power of appointment is not exercised.

General Definition:
A "power of appointment" is a unique power given to a donee (holder) by a donor to distribute the donor's rights, assets, or items usually at the donor's death to appointees.  A donee of a power of appointment is different than a personal representative or trustee.  A donee of a power of appointment does not have the responsibility of managing a person's estate or trust assets.  Rather, the donee has the authority to appoint the donor's rights, assets, or items to appointees.  There are two types of powers of appointment: a general power of appointment and a limited (special) power of appointment.  Each of these types of powers carries different and significant tax implications.