Updated January 2018 — 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).
Amy Jucoski, National Planning Manager with Abbot Downing, has taken part in many of those discussions with clients herself. “The POAST is a planning technique that can provide support for aging parents during life and give them the resources needed to help shelter more family assets from tax at death,” she says.
“My experience is that clients who are in a position to help support their parents do so outside the framework of trust planning. The POAST, however, provides an option for supporting parents in the context of an overall wealth transfer plan for the family that may be more advantageous.” 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. The tax exclusion was set at $5 million per individual, indexed for inflation. As of 2017, an individual had 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 could apply his or her GST exemption to protect up to $5.49 million of transfers from additional transfer tax.
“The POAST is a planning technique that can provide support for aging parents during life and give them the resources needed to help shelter more family assets from tax at death.” — Amy Jucoski, National Planning Manager, Abbot Downing
The passage of the Tax Cuts and Jobs Act at the end of 2017 (the “2017 Tax Act”) doubled the exclusion for the estate, gift, and GST tax — meaning starting in 2018, the exemption is $11.18 million per person and will continue to be adjusted each year for inflation. Without further action from Congress, the increased exemption is set to expire December 31, 2025, at which time the exemption will revert to pre-2018 levels ($5 million, indexed for inflation).
“The tax exemptions are a powerful tool made permanent by ATRA,” Jucoski says. Proper use of the exemptions, at any level, may provide an opportunity to cut down, or even eliminate, the amount of assets subject to federal estate, gift, and/or GST tax.”
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 they can exercise at their death. “There are several potential benefits of such power. First, assets in the trust receive a step-up in tax cost basis to the date-of-death value, meaning tracking is simpler, and the assets, if immediately sold, avoid any income tax,” Jucoski says. “Also, the power holder is treated as the owner of the assets and can transfer the assets using his or her remaining estate and GST exemptions. Use of the exemptions can help shield assets from future transfer tax for an indefinite period.”
Jucoski 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 ($2 million tax cost basis) into a POAST (“the trust”) with your father, along with your descendants, as the beneficiaries. Also assume the trust provides for distributions to your father if support is needed, and if not, assets remain in trust. Upon your father’s death, he is granted a general power of appointment over the trust assets, and by default, assets will remain in trust for future generations, Jucoski says. The $4.9 million transfer to the trust would result in a taxable gift to you, but the future benefits of the trust could far outweigh any current gift tax implications.
To keep this example simple, let’s assume prior to your father’s death he accumulates no additional assets, no distributions were made from the trust, and he chooses not to exercise his general power of appointment. As a result of having the general power, the trust is includible in his estate, meaning, your father’s estate includes the trust assets of $4.9 million plus his $100,000. Because his estate is valued at an amount less than the estate tax exclusion (currently $11.18 million), there will be no estate tax. The way the income tax rules work, the estate assets will receive a step-up in tax cost basis to the date-of-death value, Jucoski adds. As a result, the income tax basis of the trust assets is increased from $2 million to $4.9 million. Your father also applies his remaining GST exemption to the trust assets, allowing assets to continue in trust for the benefit of future generations, estate and GST tax-free.
In the example, even if your father’s estate had exceeded the threshold for the estate tax, the trust can be structured to limit the general power to help ensure that your father incurs no estate tax liability. “Assets not subject to the general power means that no step-up in tax cost basis is available for income tax purposes at your father’s death because these assets would not be part of his estate,” says Jucoski. “However, your father also avoids the 40 percent estate tax bill on this portion of the trust assets.”
“Bottom line,” Jucoski concludes, “establishing the POAST results in a taxable gift to you, which may or may not result in gift tax paid, depending on your personal remaining lifetime exemption. No matter, you have implemented a structure that improves your father’s financial well-being during life, if needed, gives your father the chance to put his otherwise wasted estate and GST exemptions to use at death, and lets the trust assets receive a step-up in tax cost basis to date-of-death value, resulting in lower income tax upon sale.”
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 note of caution that applies to any estate planning decision: A POAST should be created in the context of your overall financial picture and objectives, Jucoski says. “While the next seven years should provide for unique planning opportunities, individuals should continue to work closely with their advisors to understand the impact the tax exemption and its planned reversion may have on estate plans. Creating a POAST should complement and enhance your estate planning goals, and if done properly, both senior family members and future generations can benefit.”