Direct transfer designations, like POD’s (payable on death designations) and TOD’s (transfer on death designations), and simple beneficiary designations, are mechanisms by which an account or other asset is transferred or paid upon the death of the account holder or asset owner to a beneficiary. They are often recommended by the administrator of the account, such as a bank, broker or life insurance company. While these can be very effective and inexpensive means by which to avoid probate and transfer assets at death, they are not without their risks and challenges. A lack of careful consideration of the risks and rewards of these mechanisms can be disastrous. A carefully prepared estate plan will consider, and resolve, all of the risks and challenges of these mechanisms.
Benefits of Direct Transfer Designations
Direct transfer designations, such as POD’s and TOD’s have several benefits. The most important benefits are that they are cheap and easy. Most institutions will permit you to make such designations as a service, for no additional fee. They are simple to create, and there is no need for an attorney or other professional. Most of these designations are made by account owners without legal or professional advice or counsel. Particularly because of this simplicity, they are very popular.
The second benefit is that the payment or transfer is more or less immediate and direct. Where there is a need to make cash or other liquid assets immediately available to a child or grandchild for some purpose, a TOD or POD appear attractive at first glance. Beneficiary transfers, however, typically require claim forms, and documentation in support of the claim. In reality, the process may take more time and effort than succession of ownership (such as through a living trust or joint tenancy with right of survivorship). Nonetheless, it is the assumption that funds are available immediately that often causes folks to choose direct transfer designations.
Unquestionably, direct transfers can have unique benefits as a result of this direct payment, whether or not immediate. For example, if you are widowed and want the bulk of your estate to pass to your children, but still desire a particular asset, fund, account or benefit to pass to a significant other or second spouse, without involvement of your children, a direct transfer may be warranted. Of course, such circumstances are specific, unique, and situational. The proper method for accomplishing an intended result depends upon first carefully considering all options to ensure that the proper tool is selected.
The third benefit is that a direct transfer designation may avoid probate, provided, however, that the beneficiary, transferee, or payee is alive at the death of the account holder or owner. If the beneficiary passes before or after, the asset may be probated. Particularly because the avoidance of probate may not be effective, TOD’s and POD’s are of limited utility in a carefully planned estate. Not surprisingly, because they are available at little or no cost, they are often used for the sole purpose of avoiding probate as an inexpensive substitute for more comprehensive planning. Make no mistake that these devices are NOT substitutes for living trusts. If you have utilized TOD’s or POD’s in your estate plan, particularly if you have done so without professional guidance, you may want to consider carefully the many possible disadvantages of these tools, and consider a more appropriate planning technique.
Regardless, these designations do not, at least effectively, accomplish several goals that might be accomplished by proper estate planning. For example, these devices do not avoid estate taxes, reduce the risk of guardianship, or permit management of assets during periods of incompetency or incapacity, and may not even avoid probate of the asset.
Moreover, there are several potential drawbacks to such devices, particularly if they are used without careful consideration or the advice of counsel. The biggest drawback to these plans is that they do not plan for contingencies. Additionally, use of such designations can cause illiquid estates, can lead to or cause unintended disinheritance, can lead to lawsuits or disputes, and can facilitate or encourage guardianship.
The limitations to such planning devices are discussed further below, followed by a discussion of their potential disadvantages.
Direct Transfer Designations Do Not Avoid Estate Tax
If you have any incident of ownership in or to an account or other asset, it will be included in your taxable estate for estate tax purposes. Consequently, direct transfer designations are not appropriate tools for estate tax planning, if your intention is to remove the value of the asset from your taxable estate. Generally, unless some other reason for excluding the account exists, the account will be included in your taxable estate notwithstanding the direct transfer designation.
POD’s and TOD’s May Not Avoid Probate
There are numerous instances where these techniques have been used to avoid probate, and yet the assets of the estate were nonetheless probated. Transfer upon death designations are not typically made for personal property, and may in fact be unavailable to transfer such assets. Under recent Ohio law, a transfer upon death deed was unavailable for real property that was owned jointly with a right of survivorship, as is most real property owned by a husband and wife. Regardless, if there are sufficient assets to probate, the other assets will pass through probate, even if liquid or other property avoids probate.
Moreover, these designations do nothing to protect assets from administration by a guardian or conservator in the event of incompetence or incapacity. They also do not prevent challenges to a will, appointment of executor, or other legal disputes which may ultimately be resolved by the probate court.
Finally, these designations will not avoid probate if the beneficiary passes away either before or after the account or asset owner. A probate administration may be necessitated, whereas property passing by way of trust will not need to be probated in the event of a death of an heir.
Direct Transfer Designations Do Not Avoid Guardianship
Direct transfer designations do nothing to protect assets from administration by a guardian or conservator in the event of incompetence or incapacity. For more information regarding the danger of guardianship, consider he Open Letter to Congress, drafted by the National Association to Stop Guardian Abuse.
Direct Transfer Designations May Create Illiquid Probate Estates
One potential drawback to these designations, particularly when placed on all liquid checking, savings, and investment accounts is that an estate can be made illiquid. Lack of liquidity can be a problem where there is real estate, personal property, or other assets that must be probated. Probate administration and estate taxes must be paid, and if the probate estate is insufficient to do so, heirs may be required to return cash to the estate, or property may be sold at fire sale prices to satisfy obligations. It is important to consider that ad hoc asset level planning to avoid probate often leaves assets to be probated.
Direct Transfer Designations Do Not Plan For Contingencies
The biggest disadvantage is that these devises are usually limited, and do not provide for contingencies. These plans very rarely answer the “what if?” questions considered by a carefully prepared estate plan. For example, what if the transferee or payee dies shortly before or after the owner? In most cases, the designation will simply pay the estate of the deceased transferee or payee. If, for example, the payee is your son, and he dies before you, without a will, the account or
asset will be paid in whole or part to your daughter-in-law. You may desire that no part of your estate pass to the spouses of your children, in order to protect your grandchildren in the event of remarriage. Moreover, if you intended to avoid probate of your assets, you may fail in your efforts.
There are numerous examples of contingencies that a living or testamentary trust can address which are not typically addressed by POD’s and TOD’s. What if the property passes intentionally or unintentionally to a minor? Do you want the property to be distributed to the minor upon his or her reaching age eighteen or obtaining emancipation, or would you prefer to protect minors from their inexperience and lack of wisdom in managing assets?
What if the heir has financial difficulties, lawsuits, judgment liens, tax liens, or similar problems at the time of your death? If you do not intend your assets to pay the claims of third parties against your heirs, you should consider an alternative to a simple TOD or POD.
What if your heir is undergoing a divorce, dissolution, separation, or other marital difficulty? A TOD or POD may or may not be involved in such a dispute, depending upon a number of factors and your state law.
What if an heir is handicapped mentally or physically at the time of your death. If you want to protect that heir, you may want more than a simple TOD or POD.
What if an heir suffers from a substance abuse or other dependency that could affect their ability to manage their affairs? TOD and POD clauses rarely protect a family from such contingencies.
What if an heir joins or becomes a member of a quasi-religious organization, cult, or other organization pursuant to which your heir agrees to surrender or deliver all of the heir’s assets? You may not want your worldly possessions to facilitate or benefit a cult.
What if there is a dispute, contest, or lawsuit? How is the dispute to be resolved, and on what basis?
Regardless which “what if” question concerns you now, you should consider many possible contingencies. As a result, a carefully considered and well drafted estate plan will consider and provide solutions to all of these and many more. TOD’s and POD’s simply have no solutions, because they are not, in and of themselves, “plans.”
Direct Transfer Designations Can Lead to Unintended Disinheritance
Another disadvantage of direct transfers is that they can lead to unintended disinheritance. This occurs because folks often use these to segregate accounts. In other words, a person will select one account with a TOD or POD designation for one heir, and another account for another heir. This is often done to keep confidential account balances which may favor one heir as against another. These can be disastrous in an estate plan. Consider the following example:
Widow Smith has three children and three CD’s. Two CD’s are worth ten thousand dollars, but the third is worth twenty five thousand dollars. Smith’s oldest daughter lives very near, is often helpful in Smith’s day-to-day activities, and is Smith’s designated attorney-in-fact. Smith makes the larger CD payable upon death (POD) to the oldest daughter, but makes the others payable to the other children. Unfortunately, Smith suffers a stroke and undergoes lengthy period of convalescence, including a stay in a nursing home. The expenses require the daughter, now acting through power of attorney, to liquidate one of the smaller CD’s, and to liquidate the larger CD to cash, of which she spends ten thousand dollars. Assuming the only assets remaining at Smith’s death are the checking account, which is now worth only approximately 15 thousand dollars, and the remaining CD which is worth ten thousand dollars, you can see how the POD failed to effectuate her wishes. The checking account is divided equally between the children (5 thousand dollars each) (Widow Smith probably assumed like many people that the checking account will only have a nominal amount of money in the account, which may not be true as the family deals with medical or other crises). Therefore instead of the oldest daughter receiving twenty five thousand dollars, she receives only five thousand. One of the other children receives fifteen thousand dollars. It is obvious the results were not in keeping with the intentions of Widow Smith.
An Attorney-in-Fact May Change Your Wishes
Most people who have utilized direct transfer designations assume that their estate plan is set, and their wishes will be followed. Sadly, nothing could be further from the truth. A direct transfer designation is typically a contractual right, which can be changed by an attorney-in-fact. Moreover, an asset can be transferred, and the designation “undone” by any person with authority over you or your estate, such as a guardian or conservator. Bottom line? A beneficiary designation is simply not an adequate estate plan for most people.
Direct Transfer Designations May Lead to Lawsuits Or Disputes
For all of the foregoing reasons, and countless others, direct transfer designations may cause your estate to be disputed, and may encourage, rather than discourage lawsuits and litigation. There is no substitute for a carefully considered and well drafted trust to ensure that your wishes are expressed and carried out.
Direct Transfer Designations May Facilitate or Encourage Guardianships
Particularly because they may create expectations in the minds of heirs, and because their use certainly does not discourage, and may encourage disputes, reliance on these in your estate plan might even encourage a guardianship application by an otherwise well-meaning heir as he or she seeks to protect their inheritance from others.
Guardianship may be necessitated by assets passing to contingent beneficiaries, as well, such as underage grandchildren. Since the goal of such designations is, in part, avoidance of probate, carefully consider their use in an estate plan.