By: Elliott Stapleton
There seems to be a common misconception that adding a Transfer on Death (TOD) designation (also known as a beneficiary designation) to assets will cure all concerns at death. For the majority of families, this is not an accurate belief.
While a TOD may avoid Probate, it does not solve all family concerns at death. The following is a summary of common concerns and potential solutions.
- Certainty in your Contingency Plan
Adding a TOD, without a Trust, may help you avoid probate and direct assets to a surviving beneficiary unless the beneficiary predeceases you. In that circumstance, we cannot be sure what will happen if there is a predeceased beneficiary, as the path and options would depend on the TOD form and related agreement.
If you’re like most people, you probably have not read the terms of your customer agreement with each financial institution where your funds are located. If you’re a financial advisor, you may have read the terms, but cannot legally advise a client on your understanding of the customer agreement.
If you did read the customer agreement, you would see there is an assortment of options. These options could include payment to the children of the decedent, payment to the other listed beneficiaries, or even payment to the estate of the deceased beneficiary (meaning the likely beneficiary would be the surviving spouse of the decedent).
These agreements are also governed by different state laws. Here is a shortlist of state laws for common accounts:
- Charles Schwab = California law controls some accounts while Nevada law controls others
- E-Trade = New York law controls
- Fidelity = Massachusetts law controls
- MetLife = Unknown, there does not appear to beneficiary or customer agreement available online
- Vanguard = New York law controls
While there may be no issue with any of these institutions or different state’s law controlling, the key concern is we don’t have certainty on your contingency plan.
Even if you have fully read the terms and are satisfied today, the institution can change the plan at any time without your consent.
Potential Planning Solution: If upon your death, your account is either owned by or transfer on death to a properly drafted Trust, the terms of the Trust can articulate the plan for distribution. This could include provisions which account for potential death, disability, divorce, or creditor issues of the beneficiary. The terms of distribution to minor or young adult children could provide for the health, education, support, maintenance, and only distributing at a more mature age.
- Potential Delay in Distribution
If assets are going to one surviving child/beneficiary, the process is likely going to be quick. In families with multiple children/beneficiaries, before an account is distributed, generally all beneficiaries must submit their respective claim forms. This could be a requirement by the institution to ensure there is not going to be a dispute on the distribution of assets (note: if there is a dispute, some institutions require submission to arbitration outside of Ohio to resolve disputes).
What happens if a beneficiary is not accessible, in a nursing home, traveling abroad, or not happy with the circumstances surrounding death? In these examples, there could be gridlock in the distribution of assets until all forms are correctly submitted.
A significant delay could also be harmful to decedent’s investments. For example, if the decedent was heavily invested in P&G and there is a significant drop in the value of assets after death but before the claim forms are received, a significant portion of the total assets being transferred could be lost.
Potential Planning Solution: If upon your death, your account is either owned by or transfer on death to a properly drafted Trust, your Trustee(s) can claim the assets upon your death. Once the assets are under the control of the Trustee, there is a duty to diversify assets to reduce any investment risk.
- Who is in charge?
If all assets distribute immediately to multiple beneficiaries with a TOD (and without a Trust), there may be no one in charge of the distribution of your assets. But if no one is in charge, who pays your final funeral bill, final taxes, home expenses before the sale (utilities, property taxes, insurance), and generally takes charge of the process?
In practice, one child or beneficiary steps up and pays all of the above expenses out of pocket. After payment is made, this responsible beneficiary now has to seek voluntary repayment from their siblings.
When real property is transferred directly to beneficiaries with a TOD, all of the beneficiaries’ ownership immediately vests upon death. While at first, this may seem ideal, in practice if title immediately vests that means all beneficiaries and all spouses of the beneficiaries must agree to the terms of the sale (to release dower rights).
This process could work if all beneficiaries are perfectly aligned in their spending, financial beliefs, and not having marital troubles. If that is not the case, the outright distribution can cause tension in the family.
Potential Planning Solution: If upon your death, your assets (including real property) are either owned by or transfer on death to a properly drafted Trust, the assets go into the Trust under the control of your Trustee(s). This ensures all enforceable debts, expenses, and taxes are paid – only then will the net proceeds be distributed and divided (without the need to involve a spouse of your beneficiaries).
- Should I use a TOD?
There can be a valuable use of a TOD in an estate plan. This value is context specific and requires careful consideration with your estate planning attorney.