What is the Five by Five Power of Appointment?

In my last newsletter, I wrote about the use of powers of appointment in a person's estate plan. This month I will describe more specifically one special type of power of appointment - the Five by Five Power of Appointment

As a reminder, powers of appointment ("PoA") arise when the grantor/testator authorizes an individual, also known as the holder, to dispose of certain property/asset that is controlled by the will or trust. The grantor may give either a general or limited power of appointment. Many times, when giving powers to an individual, a major concern is to ensure that the value of the assets is not included in part of the holder's estate for estate tax purposes at the holder's passing.

One way to avoid including the assets under the individual's "control" and not be included in that individual's taxable estate is by utilizing the "Five by Five power." Under this power, individuals are annually able to access the principle or corpus of a trust in an amount equal to the greater of $5,000 per year or 5% of the fair market value of the trust each year. Hence, the name "Five by Five power." Using this standard can provide the beneficiary a minimum income stream each year, regardless of the trust's income. The ideal situation arises when the grantor merely wants to provide supplemental income to the beneficiary, or if there are concerns that the income from the trust will sometimes waver. This PoA will also ensure that the trustee-beneficiary does not exhaust the trust in the first year, a concern for many who may have free-spending relatives.

There are several negatives to this power however. First, the funds subject to the Five by Five power, including income and principle, are attachable by creditors. Thus, trust assets may end up in the hands of individuals the grantor had not planned. For example, a creditor could petition the court requiring the beneficiary to exercise the withdrawal power each year and every year in order to satisfy the creditor claim. This may not seem like a major issue. But, for example, if the creditor has access to a $2,000,000 trust, five percent of that is $100,000. In just 10 years, one creditor could amass $802,526.10 of the trust value.

Second, five percent may be an extremely substantial amount. Consider the same $2.0 million. If the goal is to limit the ability to deplete the trust, or to limit the income gained from the trust, allowing a $100,000 withdrawal may not be an ideal amount. It should be noted that in a trust of $2.0 million, it would still take just under 80 years to remove all of the trust's funds using a five by five power, and that is if no income is added to the trust corpus and increase in the value of the trust assets. Even with an growth rate of only 1.25% being applied to the trust assets, the trust funds would not be exhausted for almost 97 years. Thus, it is not perfect for extremely long-term savings, the five by five power does help to prolong the trust's life.

Another disadvantage is that, while the entire trust will not be subject to estate tax at the beneficiaries death, any amount the trust beneficiary had control of under the five by five power will be considered part of the trust beneficiary's taxable estate. In short, that means that the annual withdraw amount (i.e. greater of $5,000 or five percent of the value of the trust) will be included within the trust beneficiary's estate for estate tax liability determination and taxed accordingly. Further, under I.R.C. §678(a)(1), a beneficiary is treated for income tax purposes as the owner of any amount solely exercisable to themselves, whether or not they have actually taken in the amounts. In layman's terms, the trust beneficiary would have to pay income taxes on the amount the trust beneficiary could vest in himself or herself, even if the trust beneficiary never received the money.

Despite what may look like more negatives than positives existing, the use of a five by five power can be extremely beneficial when used in the right situations. For example, if the goal is to create a trust with diminishing returns over time, perhaps to assist children as they grow up, the use of a five by five power may be perfect. The trust will yield less and less money each year, hopefully inversely to the trust beneficiary's income. Similarly, if the idea of the trust is to provide a mechanism to offset any years of low trust income, then the insertion of a five by five clause may be perfect, as the trust could contain language such as "I give to the beneficiary of the trust the greater of the annual income of the trust, 5% of the trust's worth, or $5,000."

No matter how it is exercised, all grantors should be aware of the benefits and drawbacks, and to consult with their estate planning professionals should questions arise.

Basics of Estate Planning: Five Wishes

In the past, I have written about how an advanced medical directive ("AMD") allows an individual to lay out medical directions to caregivers, loved ones and medical personal. An AMD is important in detailing an individual's desires for medical care, particularly towards the end of their lives. A properly written AMD would lay out things such as recitation orders, detail with whom the decision making powers lay when they were incapacitated, and any other medical wishes they may hold. Over the last several years, an alternative document called the "Five Wishes" has emerged for those individuals wishing to give more life and body to their end of life requests. The Five Wishes document is valid in 42 states and D.C. Similar to your will and AMD, this document must be signed and witnessed, and it is important to inform people that you have such a document, to ensure that your wishes are followed.

The Five Wishes document was the brainchild of Jim Towey. Towey spent 12 years working with Mother Teresa and became inspired by her work to help patients find a better way to deal with end of life planning. The Five Wishes document is described as "the first living will that talks about your personal, emotional and spiritual needs as well as your medical wishes." Towey believes that the major difference between this document, as compared to traditional documents, is that it not only discusses a wider range of wishes, but also does so in a way that makes it easy for others to truly understand your needs.

There are…obviously…five sections to the Five Wishes document.

The first section is entitled "The Person I Want To Make Health Care Decisions For Me When I Can't Make Them For Myself." Similar to the durable power of attorney for health care, this wish names the person you want to make your health care choices for you once you cannot. For this clause to trigger, the form requires that:

  1. Your attending or treating doctor finds you are no longer capable of making health care choices, and
  2. a second health care professional agrees that this is true.
Your state of residence may have different rules regarding this finding by a doctor but the form dictates that the state's method of determining incapacity will rule for the document to be valid. The document allows you to name a first, second and third person to make healthcare decisions for you if you cannot. You can further list different powers the individual may hold, along with an open space to list others directions. This enables you opportunity to limit, or expand, an individual's power as you see fit. For example, should you not wish to be placed into any sort of assisted living or hospice facility, you may remove that power from the list.

The second wish, entitled "My Wish For the Kind Of Medical Treatment I Want or Don't Want". This lists what, in addition to your health care agent's decisions, you wish to have happen in the event of different medical scenarios. This section is similar to a person's Living Will. For example, if it is determined you are close to death, in a coma and not expected to recover, or suffering from permanent and severe brain damage, you can provide instructions related to your medical treatment. This wish allows you to detail things such as do not resuscitate orders, and to ensure that loved ones do not have to guess at your wishes.

The final three wishes are much more abstract having less to do with actual medical care. Because of this, the Five Wishes document makes clear that individuals are not required by law to do these things, and that it is purely a request. The third wish is entitled "My Wish For How Comfortable I Want To Be." This wish allows you to detail to your loved ones your wishes for things such as tending fevers, bathing, grooming, religious readings, and other things that are still at the forefront of people's minds but perhaps do not address true medical care. Wish four is called "My Wish For How I Want People To Treat Me", and lists what you may want while hospitalized, including having people with you when death may come, to have members of your faith informed of your illness and asked to pray for you, and where you would like to have your passing take place. The final wish, called "My Wish For What I Want My Loved Ones To Know", is undoubtedly the most personal of the wishes. In this list, you are able to inform people that you are seeking their forgiveness, to let loved ones you know they love them, to choose where and how you would like to be buried or cremated, any funeral requests, and to list any other end of life desires.

A well-drafted AMD complimented by a letter of final instructions accomplishes many of the same objectives as a Five Wishes document. But, for those individuals wanting a document without a heavy layer of legalese, the Five Wishes are an excellent tool for someone wishing to create a plan that moves beyond the economic and medical information, and instead discusses the more spiritual and emotional issues that come with end of life care and decision making. To find a copy of the Five Wishes, visit here

Estate of the Month: Jazz Great King has Royal Estate Problem

Born Riley B. King in 1925, blues legend B.B. King passed away in Las Vegas on May 14, 2015. King was known for songs such as Three O' Clock Blues, Every Day I Have the Blues, Why I Sing the Blues, and The Thrill is Gone. King was inducted into the Rock and Roll Hall of Fame in 1987. He died from complications of Alzheimer's disease along with congestive heart failure and diabetic complications. However, several of King's daughters allege that he was murdered through the use of poisons meant to cause stroke like effects. ). Needless to say, the fight over his estate began almost immediately.

A will dated January 18, 2007 named LaVerne Toney to be personal representative of King's estate. Toney was King's manager and oversaw King's road show for 39 years. Even if King's daughter's allegation were not enough several other issues have arisen. First, several of King's 15 children petitioned to have Toney removed as personal representative. The petitioning children had two main reasons to remove Toney. First, two of King's children alleged that both Toney, along with King's personal assistant, poisoned King to hasten his death. That claim fell apart with the recent release of an autopsy report confirming that King died from complications that arose from Alzheimer's disease, along with coronary disease, heart failure and the effects of Type 2 diabetes and not poison.

Second, in the past King's daughters accused Toney of elder abuse and burglary of King's property. A Las Vegas judge dismissed both of those claims. The daughters have also accused Toney of keeping them, as well as the rest of their family, away from their father and of stealing their father's money. Toney argued that it was the personal decision of King to not have those family members nearby. These claims were sent to the Clark County District Court, and on June 25th Clark County District Judge Gloria Sturman ruled that Toney would remain the personal representative of King's estate.

Along with the challenge to Toney's appointment, King's family has also made several other contentions. The daughters claim that there is a second will in existence. The Las Vegas attorney, who drafted King's will in 2007, said he is unaware of any other wills existing. This claim was echoed by Toney.

There are also disputes about the value of King's estate on his passing. In a running theme of who is putting up the biggest obstacles for a personal representative, King's daughters claim the estate is worth between $5 and $10 million. The basis of their claim is the undervaluation of the intellectual property rights to King's music. While this claim is disputed by Toney and her attorneys, a court document filed in April related to the abuse allegations valued one bank account at around $5 million in 2014, and a home at $330,000.

Toney's attorney defense to the claims is that most of King's estate is in trust. Toney, in many of her responses to the claims above, cites the terms of King's trust as the reason his descendants are upset about the proceedings. The terms of King's trust left between only $3,000 and $5,000 to his children and grandchildren. The lack of inheritance is likely one motivating factor for many of King's children. However, King did leave a larger amount to help his descendants pay for college and other related expenses.

There still much to be decided with respect to King's estate. Given the level of discorded between Toney and some of King's children prior to and after his death and a substantial estate at stake, the proceedings will likely carry on for several more years.

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