This blog post discusses the use of Lifetime Income/Power of Appointment Trusts in estate planning, especially in light of potential reductions in the estate tax exemption in 2026. This type of trust works in conjunction with a credit shelter trust and the marital deduction and can limit estate taxes. It offers the surviving spouse a lifetime income and decision-making power over who inherits remaining assets. It provides flexibility, but less control over asset distribution compared to other trusts. The trust must meet certain conditions to qualify for the marital deduction.
You should care about Power of Appointment Trusts because even if you thought your estate would never be subject to estate taxes, this may change when the current very large exemption of $12.92 million in 2023 sunsets on January 1, 2026, and gets cut in half. While this law may be changed or repealed, you need to be prepared. See also here. By using the marital deduction and the use of specific trust vehicles, you may be able to break the estate up into a marital trust and a credit shelter trust to limit estate taxes that otherwise would be due. This type of planning relies on the availability of the unlimited marital deduction which enables a spouse to shift any amount of assets to the other partner without triggering a tax (gift tax during life, estate tax at death). As stated, this transfer between spouses can happen either during their lives or following the death of one spouse. While an outright transfer (without a trust) is possible, for comprehensive planning a “marital trust” is commonly used as part of a two-trust arrangement (AB trust planning). The most commonly used marital trusts in this context are the “Power of Appointment Trust”, the subject of this post, and the QTIP trust, previously explained here.
Introduction and Purpose of the Lifetime Income/Power of Appointment Trust
The Lifetime Income/Power of Appointment Trust is a frequently used estate planning tool, designed to take advantage of the marital deduction in the U.S. tax code. It needs to be drafted carefully so it actually works to your benefit. This provision allows assets transferred to a spouse to be exempt from federal estate and gift taxes, effectively deferring estate taxes until the surviving spouse’s death. This will likely become again important when the current very large exemption sunsets on January 1, 2026 and gets cut into half. See also here.
Understanding Lifetime Income/Power of Appointment Trust
In a Lifetime Income/Power of Appointment Trust, the surviving spouse is granted both an income interest and a general power of appointment. This means the surviving spouse receives an income from the trust for their lifetime and also has the ability to decide who will receive the remaining trust assets after her death. The power of appointment can be testamentary, meaning it is expressed in the will, while the specific provisions regarding its execution are detailed within the trust document itself. Often, the trust agreement allows the surviving spouse access to more than just the income generated by the trust. It’s common for the spouse to have the added benefit of tapping into the trust’s principal during their lifetime. This right to draw from the principal isn’t necessarily confined by any specific standard, allowing for broad flexibility, although it can be limited by an ascertainable standard or other guidelines if the trust specifies. The ability to use the principal is intended for a wide range of purposes, from covering the spouse’s personal needs or unexpected expenses to enabling them to give gifts to third parties during their lifetime.
Advantages and Limitations of Lifetime Income/Power of Appointment Trust
The Lifetime Income/Power of Appointment Trust offers some unique advantages. First, it doesn’t require the executor to make an irrevocable election on the estate tax return, reducing the likelihood of losing the marital deduction due to oversight or neglect. However, it provides less control over the ultimate disposition of trust assets compared to some other trust structures, such as a Qualified Terminable Interest Property (QTIP) Trust.
Qualification for Marital Deduction
The trust must meet five conditions to qualify for the marital deduction:
- The surviving spouse must be entitled for life to all of the net income from the entire interest or a specific portion.
- The income must be payable to the spouse annually or more frequently.
- The surviving spouse must have the power to appoint the entire interest or the specific portion to either himself or herself, or to his or her estate.
- The power must be exercisable by the surviving spouse alone and must be exercisable in all events.
- The entire interest or the specific portion must not be subject to a power in any other person to appoint any part to any person other than the surviving spouse.
Additional Features and Options
The Lifetime Income/Power of Appointment Trust can be created as either revocable or irrevocable, depending on the preference of the attorney and the wishes of the clients. The surviving settlor’s power to revoke the trust gives them absolute control over the trust assets. On the other hand, making the trust irrevocable increases the likelihood that trust principal will be preserved for the ultimate appointees or remainder beneficiaries but deprives the surviving settlor of a measure of control over the trust assets.
Powers of Appointment – An incredibly flexible estate planning tool
