Powers of Appointment Primer Part 1: The Colorado Uniform Powers of Appointment Act, 0618 COBJ, Vol. 47, No. 6 Pg. 54
| Author | SUSAN L. BOOTHBY, LISA C. WILLCOX, AND GRIFFIN BRIDGERS, J. |
| Position | Vol. 47, 6 [Page 54] |
TRUST AND ESTATE LAW
SUSAN L. BOOTHBY, LISA C. WILLCOX, AND GRIFFIN BRIDGERS, J.
This is the first in a two-part series exploring the powerful benefits and complex issues confronting estate planning attorneys in using the power of appointment. Part 1 discusses Colorado law relating to powers of appointment. Part 2 will address associated federal income and transfer tax issues.
“The power of appointment is the most efficient dispositive device that the ingenuity of Anglo-American lawyers has ever worked out.”1
A power of appointment is the power given by the owner of property, who has the authority to decide who will enjoy his or her property, to another person to determine who will enjoy the ultimate beneficial ownership interest in that property. Powers of appointment are often created in trusts. For example, assume your client, Ms. Wilson, wants to create a lifetime trust for her daughter, Julie. If the trust has assets at Julie’s death, Ms. Wilson wants the trust assets to benefit Julie’s children. Ms. Wilson understands that circumstances may change for her grandchildren and she trusts Julie will be in the best position to make appropriate adjustments to the bequest to Julie’s children. The estate planning attorney may consider drafting a trust providing Julie with a testamentary nongeneral power of appointment, such as:
Julie shall have the power to appoint, by valid will that refers to and specifically exercises this power, the principal and all accrued and undistributed net income of Julie’s trust among Julie’s descendants as she selects. If this nongeneral power is not validly exercised, in whole or in part, then upon Julie’s death, the trustee shall distribute the unappointed principal and accrued and undistributed net income to such of Julie’s then living descendants, per stirpes, or if there are none, to my then living descendants, per stripes.
By creating a power of appointment, Ms. Wilson confers the authority to determine who will enjoy the ultimate beneficial ownership o f her property on Julie. In other words, once a power of appointment is created, Julie gets to choose who will receive an interest in Ms. Wilson’s property.2
The decision of whether to use a power of appointment involves significant federal income and transfer tax[3] issues. Additionally, depending on the confidence the client has in the power holder, its use may not even be desired. Moreover, the granting of a power of appointment (and how broadly or narrowly it can be drafted) demands an understanding of Colorado law on the requirements of creating and exercising powers of appointment.
When estate planners draft trusts, they are challenged to provide maximum flexibility for the trustees and beneficiaries while maintaining the intent, wishes, and purposes of the client. But circumstances change over time, and almost all estate planning attorneys who represent beneficiaries or trustees have had the uncomfortable experience of grappling with an inflexible trust drafted years ago. To address unforeseen circumstances, such as a change in a remainder beneficiary’s circumstances or a federal tax system overhaul, the Colorado legislature has devised methods to alter inflexible trusts.4 But altering these instruments may be challenging. For example, corporate fiduciaries are understandably reluctant to reform, amend, or decant a trust document without court approval, which involves expense and depletion of trust assets.
Little understood except by estate planners, and considered mysterious or even arcane by other members of the Bar, the power of appointment is a tool that can provide flexibility and achieve tax planning objectives, even in uncertain times, avoiding the need for later costly alteration. This article suggests that the strategic use of the power of appointment by estate planners may enable a trust drafted in 2018 to meet unknown future challenges and provide enough flexibility to be administered in 2068.
A Clever Device
The power of appointment originated in England. It was a clever device to get around the inflexibility created by Parliament prohibiting transfers of real property by will.[5] Instead of devising the property by will, some English solicitors used the power of appointment to name in a will a person who had the power to devise the property.6 Today, powers of appointment are most commonly used in trusts.
In the past, many estate planners used trusts to plan for and attain certain tax results (tax issues will be covered in more detail in Part 2). Due to the increase of the transfer tax exclusions, many clients can transfer a large amount of wealth at death tax free.7 Even though an estate may not be subject to estate or generation-skipping taxes, a trust may still be the most appropriate vehicle for this transfer. A trust provides beneficiaries a wide array of benefits, not the least of which is creditor protection and opportunities for appropriate management of assets. But it is also important that the trust provide the flexibility to react to future conditions and reflect changes in beneficiary needs, as well as revisions of income tax, transfer tax, creditor rights, and trust administration laws. The power of appointment is one tool that provides increased flexibility to trusts.
For example, assume client Mr. Smith wants to create a trust for his son, Sam, giving Sam access to trust funds at certain stages in Sam’s life. The attorney can draft for increased flexibility by using the power of withdrawal (which is considered a general power of appointment) instead of a mandatory distributive scheme. Consider two alternative clauses:
1. When Sam attains the age of 30 the trustee shall distribute to Sam one-half of the principal of the trust as then constituted. When Sam attains the age of 35 the trustee shall distribute to Sam the balance of the principal and all accrued and undistributed net income of Sam’s trust.
2. When Sam attains the age of 30 he may withdraw up to one-half of the principal of the trust as then constituted. When Sam attains the age of 35 he may withdraw the balance of the principal and all accrued and undistributed net income of his trust.
As detailed later in this article, under present Colorado law, there may be significant differences in treatment with respect to Sam’s creditors by employing a power of withdrawal rather than mandating distributions.
Overview of the Colorado Uniform Powers of Appointment Act
Before 2014, Colorado statutory law on powers of appointment was minimal and case law was sparse. Colorado was one of the first states to enact a version of the Uniform Powers of Appointment Act (UPAA). While the UPAA was in draft form, a subcommittee of the Statutory Revisions Committee of the CBA’s Trusts and Estates section (SRC Subcommittee) studied the Act and made a few changes to it to reflect Colorado law on the subject. Although it did not significantly change Colorado statutory or common law, the Colorado Uniform Powers of Appointment Act (Colorado Uniform Act) provides comprehensive guidance to lawyers and judges regarding issues yet to be addressed by Colorado statutes or case law.8
Structure of the Act
The Colorado Uniform Act is divided into six parts:
1. General Provisions
2. Creation, Revocation, and Amendment of Power of Appointment
3. Exercise of Power of Appointment
4. Disclaimer or Release; Contract to Appoint or Not To Appoint 5. [Reserved]9
6. Miscellaneous Provisions
The most pertinent provisions of each part are described in more detail below.
General Provisions
The Colorado Uniform Act starts with a definitions section, CRS § 15-2.5-102. The definitions of specific roles central to the power of appointment are particularly important. The person who creates a power of appointment is the “donor.”10 A person in whom a donor creates a power of appointment (the person who may exercise the power) is the “power holder.”11 “Power holder” replaces the traditional term “donee,” which was a source of potential confusion.12 A “permissible appointee” is a person who may receive appointive property, while an “appointee” is a person to whom a power holder makes an appointment of appointive property.13 A “taker in default of appointment” is the person who takes all or part of the appointive property to t he extent the power holder does not effectively exercise the power of appointment.[14] Finally, an “impermissible appointee” is a person who is not a permissible appointee.15 In the Wilson example above,
■ Ms. Wilson is the “donor,” Julie is the “power holder,” Julie’s descendants are the “permissible appointees,” and Julie’s then living descendants, per stirpes, are the “takers in default of appointment.”
■ If Julie exercises her power in favor of anyone other than her descendants (such as her creditors, or her husband Herb) she has exercised her power in favor of an impermissible appointee.
Power of Appointment.
The Colorado Uniform Act defines “power of appointment” as “a power that enables a power holder acting in a non fiduciary capacity to designate a recipient of an ownership interest in or another power of appointment over the appointive property.”16 “Appointive property” is defined as property (or a property interest) subject to a power of appointment.17 Defining a power of appointment as the power holder acting in a nonfiduciary capacity is a very important distinction from the fiduciary powers held by a trustee.18
■ If Julie exercises her power of appointment she may do so arbitrarily, as long as the exercise is within the scope of the...
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