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. Recent legislative changes have made a vehicle called a Power of Appointment Support Trust (POAST) a possible solution in more and more of these situations.
Lester Law, Managing Director 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 is 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 2016, an individual has the ability to give away $5.45 million of assets during life and/or at death without triggering a gift or estate tax. This amount will increase to $5.49 million in 2017 and is currently slated to increase by a cost-of-living adjustment every year.
"Before ATRA, the exemption was somewhat uncertain because transfer tax rules were temporary," Law 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." — Lester Law, Managing Director, 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, Law says. "Additionally, the senior family member's available generation-skipping transfer tax exemption may be used to insulate these assets from future transfer tax, perhaps indefinitely."
Law 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, Law says. 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, Law 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," Law explains.
In the example, even if your father's estate had exceeded the threshold for the estate tax, he could have lowered its value below the threshold before his passing by using his GST tax exemption, meaning some of those assets could have been transferred to your children (your father's grandchildren), to whom you otherwise may not have been able to transfer assets without tax implications.
In the end, you've potentially improved your father's financial situation by creating the POAST with him as the beneficiary, but you've also taken assets out of your estate without using your own estate and gift tax exemptions or your GST exemption, meaning you still have them available for gifts to your own children and grandchildren.
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 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, Law 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."