Special versus General Powers of Appointment in Asset Protection Trusts

In a very recent article, we discussed the concept of powers of appointment in asset protection trusts.  The use of a power of appointment can be used in domestic and in conjunction with other tools creating offshore asset protection.  We did not, however, discuss the different types of powers of appointment.  There are two types of powers of appointment: General and Special.

Remember that a person with the right to name beneficiaries of a trust at some point in the future holds a power of appointment.  The person with the right to name beneficiaries is the “donee” of the power.

General Powers of Appointment

A general power of appointment allows the donee to name anyone as a beneficiary.  If you’re thinking that’s a pretty broad power, you’re right.  The donee of a general power of appointment is even permitted to name her or himself as a beneficiary of the trust!  This creates a problem: If the donee can name him or herself as a beneficiary, creditors of the donee might possibly argue that the trust assets can be used to satisfy their claims.  Indeed, creditors have succeeded in making such arguments in the past.

If the donee can legally obtain the assets in the trust, then a U.S. court might require that the donee exercise the power of appointment and pass the assets along to his or her creditors.  It should be obvious that offshore asset protection is far superior to relying on a general power of appointment in a domestic trust.  When assets are offshore, they are outside the jurisdiction of the U.S. court system and safe from creditor claims.

Special Powers of Appointment

A special power of appointment is much more effective than a general power of appointment.  A special power of appointment (i) ensures that the donee cannot him or herself as a beneficiary of the trust, and (ii) may otherwise narrow the class of permissible beneficiaries.  Because the donee of special power cannot be a beneficiary of the trust, assets held in the trust are shielded from the donee’s creditors.

Who Owns The Assets?

In essence, when the beneficiaries of a trust are left to the discretion of a special power of appointment, nobody owns the assets (though they are controlled by the trustee)!  The assets can only be owned once the special power has been exercised.  As a result, assets in a trust where the special power of appointment has not been exercised are technically safe from the claims of creditors of the trust creator, the donee of the power, and any of the potential beneficiaries of the trust.  This is a good power to grant when you are unsure as to who might be the ultimate beneficiaries.  If, however, the creators of the trust wants to benefit from their own assets, the special power of appointment becomes problematic.

Weaknesses of a Special Power of Appointment (SPA)

By funding a SPA trust, you give up ownership and control over your property.  If you wish to benefit from these assets on a regular basis, you are dependant on a friendly donee or beneficiary who is willing to gift you property that was yours, pay for things you want, or otherwise indirectly move money to benefit you.  Evidence of this “informal arrangement” probably needs to be concealed so that creditors cannot prove you retain ownership or control.  Your donee may hold the power to name you a beneficiary in the future, but this defeats the purpose of asset protection because once the donee names you a beneficiary, your creditors can claim the assets.  Anyone can obtain asset protection for others through irrevocable trusts with spendthrift provisions, but the whole point here is for you to protect YOUR assets to be enjoyed by YOU!

The SPA strategy presumes that the donee (relative or friend typically) will always use the special power in your best interest.  While trusts created around a SPA appear to protect assets from a technical standpoint, they raise the argument that while they separate you from your assets on paper, in reality you retain ownership-like benefits.  This is something that a results-oriented judge or jury could see through and reverse.

Offshore Asset Protection Is Still The Best

While use of a power of appointment might, at first blush, seem like a good alternative to offshore asset protection, the fact remains that use of a domestic trust, no matter how seemingly iron-clad, leaves trust assets within the jurisdiction of the U.S. court system, which is full of activist judges that like to make rather than follow laws.  As a result, the only way to truly protect wealth in a bullet proof manner is through offshore asset protection.