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Transfer on Death Isn’t Always a Smart Estate Planning Strategy

Estate planning terms

When it comes to estate planning a transfer on death (TOD), also known as beneficiary designation, can be a useful estate planning tool in certain situations.  This option allows you to name a beneficiary on certain assets (such as bank accounts or investment accounts) that will receive the assets automatically upon your death, without going through probate.

TODs can be helpful if you want to avoid probate costs and delays, and if you want to keep the distribution of your assets private. However, TODs may not be suitable for everyone, as they don't allow for any flexibility or control over how the assets are distributed, and they won't work for assets that have a joint owner or designated beneficiary already. Moreover, they may not provide adequate protection for assets in case of creditor claims, divorce or remarriage of the beneficiary, and other unforeseen events.

Transfer on-Death (TOD) and Payable-on-Death (POD) designations on financial accounts appear to be a simple way to avoid probate. However, they can still derail an estate plan if not coordinated with the overall plan, says a recent article from mondaq, “Transfer-on-Death Designations: A Word of Warning.”

Using a TOD or POD benefits the beneficiary and the account administrator since both avoid unnecessary delays and court oversight of probate. In addition, designating a beneficiary on a TOD/POD account is usually fairly straightforward. Many financial institutions ask account owners to name a beneficiary whenever a new account is opened. However, the potential for undoing an estate plan can happen in several ways.

TOD/POD designations remove assets from the probate estate. If family members or trusts are included in an estate plan, but the TOD/POD designations direct most of the decedent’s assets to beneficiaries, the provisions of the estate plan may not be implemented. However, when thoughtfully prepared in tandem with the rest of the estate plan with an estate planning attorney, TOD/POD can be used effectively.

TOD/POD designations impact tax planning. For example, when an estate plan includes sophisticated tax planning, such as credit shelter trusts, marital trusts, or generation-skipping transfer (GST) trusts, a TOD/POD designation could prevent the implementation of these strategies.

If an estate plan provides for the creation of a GST trust, but the decedent’s financial account has a TOD/POD naming individuals, the assets will not pass to the intended trust under the terms of the estate plan. In addition to contradicting the estate plan, such a mistake can lead to unused tax exemptions.

When it comes to estate planning, TOD/POD designations may set beneficiaries aside from the probate estate. This can sometimes lead to a disconnect with the estate plan, especially if most of the assets get directed to beneficiaries. That being said, TOD/POD can be a powerful tool when incorporated thoughtfully with an estate planning attorney. However, it's crucial to note that TOD/POD designations can also influence tax planning. Take, for instance, the use of sophisticated tax planning techniques like credit shelter trusts, marital trusts, or generation-skipping transfer (GST) trusts. When that's the case, a poorly thought-out TOD/POD could obstruct the execution of these strategies.

TOD/POD designations can create liquidity problems in an estate. For example, suppose all or substantially all of an individual’s financial accounts pass by TOD/POD, leaving only illiquid assets, such as real estate or closely held business interests in the estate. In that case, the estate may not have enough cash to pay estate expenses or federal or estate taxes. If this occurs, the executor may need to recover necessary funds from the beneficiaries of TOD/POD accounts.

TOD/POD designations can undermine changes made to an estate plan. During the course of life, people’s circumstances and relationships change. It is easy to forget to update TOD/POD designations, especially if one’s estate planning attorney is not informed of assets being titled this way. An inadvertent omission increases the risk that a person’s wishes will not be fulfilled upon death.

Did you know that a simple TOD/POD designation on a financial account could potentially put your entire estate plan at risk? Life is constantly changing, and forgetting to update these designations can lead to unintended consequences after you've passed away. Don't let an inadvertent omission be the reason your last wishes aren't fulfilled. Before making any changes, coordinate with your estate planning attorney to ensure that you're not undoing all the hard work you've put into achieving your estate planning goals.

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