Updated November 2017 — Balancing the financial needs of aging relatives and younger generations can be a challenge, and it's a frequent topic of conversation between wealth managers and their clients. One possible solution in more and more of these situations is a vehicle called a Power of Appointment Support Trust (POAST).
Patrick Beaudry, Director of Wealth Planning with Abbot Downing, has taken part in many of those discussions with clients himself. "The Power of Appointment Support Trust is a wonderful planning idea that has some very unique potential tax benefits to many of our clients who still have the pleasure of having their parents alive," he says.
"We've seen some clients who are fortunate enough to be able to give back to their parents by caring for them financially as well as emotionally. In the past, planning for that support was relatively inefficient, because you're transferring assets upstream (generally it is more tax efficient to transfer assets downstream, such as to children and their descendants)." The POAST allows for upstream transfers in a more tax-efficient manner.
What is a POAST?
A POAST is essentially an irrevocable grantor trust that has a senior-generation family member as a beneficiary who also holds a "power of appointment" over a predetermined amount of assets in the trust upon their death.
A major factor for being able to now use the POAST was the passage of the American Taxpayer Relief Act of 2012 (ATRA), which made permanent the estate, gift, and generation-skipping transfer (GST) tax exemptions: As of 2017, an individual has the ability to give away $5.49 million of assets during life and/or at death without triggering a gift or estate tax. In addition, an individual can apply his or her GST exemption to protect up to $5.49 million of transfers from additional transfer tax. [Both the estate/gift exclusion and GST exemptions will increase to $5.60 million in 2018 and are currently slated to increase by a cost-of-living adjustment every year.]
"Before ATRA, the exemption was somewhat uncertain because the increased exemptions established under the 2010 Tax Relief Act were temporary," Beaudry says. "ATRA made it permanent. With the permanency came the increased transfer tax exemptions. With such large exemptions, it opens the door for planning that was not feasible before the transfer tax laws were made permanent and expanded."
"The Power of Appointment Support Trust is a wonderful planning idea that has some very unique tax benefits to many of our clients who still have the pleasure of having their parents alive." — Patrick Beaudry, Director of Wealth Planning, Abbot Downing
Potential benefits of a POAST
Under the terms of a POAST, a trustee may distribute funds to older family members for their current needs, and such family members are also given a power of appointment that they can exercise at their death. By having that power of appointment, the tax basis of assets in the trust will receive a date-of-death adjustment, potentially eliminating any income tax on such assets on their sale, Beaudry says. "Additionally, the senior family member's available GST exemption may be used to insulate these assets from future transfer tax, perhaps indefinitely."
Beaudry uses the following example to illustrate how a POAST could work for an individual. Say your father has $100,000 worth of assets, and you transfer $4.9 million into a POAST with your father, along with your descendants, as the beneficiaries, Beaudry says. This transfer would result in a taxable gift, but the future benefits of this trust could far outweigh any current gift tax implications. Also assume those assets in the trust had substantially appreciated, having a tax basis of $3 million. As a beneficiary, if your father needs funds for support, the trustee would transfer funds to your father's accounts, and if not, the funds remain in the trust. Also, assume that your father is given a general power of appointment over the POAST's assets that he can exercise at his death. For this example, assume that over the next 10 years he does not accumulate any other assets and does not need any of the POAST's assets before passing away.
At the time of his death, because he had a general power of appointment, your father's estate includes the $4.9 million of the POAST's assets as well as his $100,000. Because his estate is valued at an amount less than the estate tax exclusion, there will be no estate tax. At the same time, the way the income tax rules work, you also get an income tax adjustment to the date of death value on all those assets in the trust, Beaudry adds. As a result, the income tax basis is increased, tax-free, from $3 million to $4.9 million.
"Because the assets were included in your father's estate, the tax-free adjustment eliminates all of the income tax that would otherwise have had to be paid on the sale of those assets had they been sold before your father's death," Beaudry explains.
In the example, even if your father's estate had exceeded the threshold for the estate tax, the POAST can be structured to limit the general power to help ensure that no estate tax liability would be due in your father's estate. "While this would limit the basis adjustment for income tax purposes," says Beaudry, "it may be worth it to avoid a 40 percent estate tax. Also, because the assets are included in your father's taxable estate, his executor can apply his remaining GST exemption, giving the assets the potential to benefit future generations without additional transfer tax implications.
"In the end," Beaudry concludes, "you've made a taxable gift to establish the POAST, but you also have potentially improved your father's financial situation during his lifetime, limited the income tax on future asset sales after his death, and protected assets from future transfer taxes through the use of your father's available GST exemption."
Create your POAST with care
When setting up a POAST, it's crucial to seek experienced legal counsel to draft the document so it not only aligns with the donor's goals but also uses the relevant exemptions and potentially provides the most tax-efficient result. And the POAST must be created for the right reason: a genuine need to support a senior family member.
A final caution could apply to any estate planning decision: A POAST should be created in the context of your overall financial picture and objectives, Beaudry says. "Make sure this POAST works with what you already have structured and what your goals are, because the POAST — when done correctly — can enhance other things that you've already set up or that you're contemplating doing."