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One of the most important components of estate planning is establishing a power of attorney. When a healthy individual suddenly becomes incapacitated, leaving them unable to make decisions, it is critical to have a financial advocate assigned to look out for their interest.

When a financial advocate, namely an individual with a power of attorney, is not assigned, the result can be situations in which the court is required to appoint a guardian, which can be costly and time-consuming, and many times it results in considerable legal expenses.

Unfortunately, I have witnessed problems in my family and in the families of friends because an individual failed to appoint a power of attorney, amassing legal expenses that could have been avoided.

In a recent article in Bob Carlson’s Retirement Watch newsletter, he pointed out some important guidelines for selecting an individual with power of attorney responsibility.

Terms to know

The financial power of attorney (POA) establishes the financial advocate. The person who signs the POA is known as the principal. The person who is empowered to act on the principal’s behalf under the POA is the agent.

The agent takes action when the principal is not able to, such as making sure that bills are paid and investments are managed properly, along with other tasks.

For assets held in a revocable living trust, or other trusts, a financial advocate is still needed. Instead of an agent there is a trustee or successor trustee. Even when most assets are held in a trust, there is still a requirement for a POA to cover any other assets not held in the trust.

When no POA is assigned, the consequences can be bills not being paid on time, financial abuse or theft.

Who to choose

It is important to choose a POA with care. Unfortunately, there are too many cases in which an individual is chosen casually and lacks the necessary skills. For example, many times a parent will choose their oldest child without carefully considering whether that person has the skills required for the necessary tasks.

The selection of the POA should be based on whether the individual is intelligent, honest and has the financial capability to do the job. The person may be required to do the job for many months or years, and must have the time for that.

Of course, an individual who has considerable wealth or complicated assets should consider appointing a professional for the POA as opposed to a relative without the required skill set.

The principal should also consider naming more than one agent, especially when the principal has significant net worth or complicated assets. Multiple agents can act as checks and balances against each other. They can be assigned different responsibilities based on their background and areas of expertise.

Although the principal gives the agent the authority to act, no one is required to recognize the POA. To minimize the risk of fraud and abuse, financial firms often set their own standards for recognizing POAs. In some cases, the selection of a POA must be certified as a bank officer in the state of residency, or be on the financial firm’s standard form.

You can avoid potential problems by working with a financial firm during the planning process. Ask the firm what their standards are for POAs and comply with them to avoid surprises.

Gifts and the IRS

Many states say that there is no implied right to make gifts under a general POA. That caused the IRS to rule that gifts made under a POA without gifting authority are not gifts for tax purposes.

For the agent to make tax-planning gifts, the POA should clearly authorize gifts. Some POAs prohibit gifts to the agents to avoid self-dealing. Some POAs state that when gifts are made, the agent must make gifts of equal amounts to all family members.

Bottom line: A principal should touch base with their financial institution before finalizing POA responsibilities if there are assets associated with their financial institution. If the principal is allowing the POA to handle gifts, they should discuss this issue with a knowledgeable attorney to avoid potential problems with the IRS related to gifts.

Elliot Raphaelson welcomes your questions and comments at raphelliot@gmail.com.

© Elliot Raphaelson. Distributed by Tribune Content Agency, LLC.