Secondary Modes of Probate Avoidance

Regardless of the estate size, a Revocable Living Trust (RLT) addresses virtually every basic estate planning need in providing the privacy, convenience, practicality, safety, aggregation, and control that everyone wants. The cost savings and administrative efficiencies associated with a fully funded RLT are established, undisputed facts. For the astute asset owner who wants to do it right, a living trust should always be the foundational estate planning tool — including for those who may have already employed secondary probate-avoidance methods such as Payable on Death (POD) accounts, Transfer on Death (TOD) accounts, and statutory beneficiary deeds.

Whether the probate-avoidance strategy is a Joint Tenancy with Right of Survivorship (JTWROS) deed, a beneficiary deed, or a POD/TOD account, there is only one reason for those structures to be utilized — to avoid probate at the decease of the asset owner. Those methods do avoid probate, but when closely examined, potential problems become apparent when such methods of estate planning are used instead of (or outside the aggregative features of) a Revocable Living Trust.

With the exception of tenants-by-the-entirety structures between a legally married husband and wife, when anyone enters into a JTWROS type of ownership of an asset with another — whether an adult child, a sibling, a friend, or a business associate — they are subjecting themselves to the possibility of total forfeiture of that property. Regardless of the jurisdiction where the property is located, each respective tenant in a JTWROS arrangement is deemed to own 100% of the property for creditor payment purposes. In other words, if a child whose name was on a JTWROS deed were to get sued, or be involved in an adverse divorce settlement, the parent could lose the entire property to satisfy the legal claim.

Problems can also arise if an unprepared JTWROS tenant were to become incapacitated prior to the time when the sale of the subject property became necessary, since a sale would require the legal conveyance of both owners. In such case, the other (non-incapacitated) tenant may need to arrange for a court-appointed conservatorship over the incapacitated tenant in order to sell the property.

Ownership by JTWROS between non-spousal tenants could prove to be an expensive method of probate avoidance for the original owner — especially considering such an arrangement is entirely unnecessary when a Revocable Living Trust easily avoids those problems and can provide the desired end result.

POD and TOD arrangements are the same in their singular function: to avoid probate of withdrawal-type accounts. POD accounts (also known as Totten Trusts) are generally offered through banks, and TOD accounts are available through most investment institutions. The account owner names a beneficiary to take title of an identified account upon his decease, and thus probate of that account can be avoided.

So, what could possibly go wrong? First, financial institutions provide these services entirely as a front-end incentive to draw and keep clientele. Such institutions are not helping to establish any kind of a purposed-design estate plan in the client's best interests, nor can they. Second, these arrangements can grow old — an ever-increasing length of time since the POD/TOD origination can become a factor causing the custodial institution reluctance toward releasing funds outright to a beneficiary without additional proof or due diligence of the deceased owner's intent. Institutions offering probate-avoidance features also do not disclose to the account owner that with such arrangements, alternate sets of potential circumstances are automatically created that might lead to unforeseen, unwanted, and even costly outcomes upon the account owner's decease.

Such minimalized, inferior methods of estate planning carry the probability of producing less-than-ideal circumstances for the executor or trustee being asked to settle the aggregate estate of the well-meaning, howbeit uninformed, account owner.

QUESTION: How will an executor/trustee obtain the funds to pay outstanding debts of the decedent's estate — medical bills, credit card bills, income taxes due with respect to the decedent, and the like, or any other unforeseen obligations — without having full control of the entire estate settlement process?

ANSWER: If necessary, a court-ordered garnishment upon the estate's heirs and other beneficiaries may have to be imposed by the trustee or executor as the only equitable solution for a fair and proper estate settlement outcome.

Any and all such secondary, inferior methods of estate planning can create adverse consequences such as the unintentional disinheritance of grandchildren. Payouts may become vested at an inopportune time — during a divorce or a bankruptcy proceeding, or under any other unforeseen and untimely condition leading to legal liability that may be enforced against a beneficiary's POD receipts.

Payable on Death structures are not exclusive or common only to banks. Such arrangements are a prominent feature of life insurance policies, beneficiary deeds, certain life estate deeds, traditional and Roth IRAs, defined contribution (401k) and defined benefit plans, tax-sheltered 403(b) annuity plans, and qualified and non-qualified annuities with remainderman interests.

When examining federal (or state) transfer-tax recovery law as prescribed in IRC §2207 regarding tax liabilities imposed upon a recipient of property — who, as an example, would be a POD/TOD beneficiary receiving a distribution outside of a trust estate or probate estate — another potential problem appears:

"Unless the decedent directs otherwise in his will, if any part of the gross estate on which the tax has been paid consists of the value of property included in the gross estate under section 2041, the executor shall be entitled to recover from the person receiving such property… such portion of the total tax paid as the value of such property bears to the taxable estate. If there is more than one such person, the executor shall be entitled to recover… in the same ratio."

This IRC §2207 rule means that unless the decedent's will or trust expressly waived the right to recover from a POD/TOD beneficiary who received an otherwise tax-free distribution outside of the will or trust, the executor or trustee will essentially be required to claw back the prorated value of tax effectively owed by a POD beneficiary. The trustee administering the decedent's estate would be legally obligated to obtain a payback from the POD/TOD beneficiary on behalf of the other beneficiaries whose allocations were reduced by the transfer tax. The consequences of a potentially adverse condition imposed by IRC §2207 because of inadequate planning are quite apparent — including the potential of forcing loved ones to face a relinquishment mandate over a portion of their inheritance which may have already been spent.

Without thoughtful and purposeful estate planning designs provided through the use of an RLT, the likelihood of complications associated with the prorated equalization among the decedent's beneficiaries — including those receiving POD/TOD distributions outside of the decedent's will or trust — substantially increases. That can turn what could have otherwise been an easy, aggregated estate settlement experience for the trustee or executor into a chaotic and time-consuming process, or worse. Estate asset aggregation using a fully funded RLT can easily and entirely remove all concerns of any such negative outcomes.

With a POD or TOD account, a Financial Power of Attorney would be required for another person or agent to handle the account. Financial institutions are often reluctant to accept powers of attorney for their various in-house or technical reasons. A funded Revocable Living Trust, by contrast, allows the asset owner to plan for incapacity; if the grantor of the RLT becomes incapacitated, the successor trustee can assume management of the account for the benefit of the creator. That process occurs because of standard operation-of-law applications and is enforced through the legal constructs of a trust.

Revocable Living Trusts allow asset-owner grantors to carefully and systematically plan for specific beneficial allocations, including contingency distributions, and to make changes whenever necessary — which is particularly the case with The eStatePlan provided through the ITS platform. If the beneficiaries are minors, have special needs, have creditor or spendthrift issues, have mental health or substance abuse issues, or are limited by physical restrictions, RLTs enable the appointed trustee to hold and manage allocated estate funds for such beneficiaries' welfare. An inheritance can be managed over years or decades with an RLT, even to second and third generations or more. That is not possible with the stand-alone use of traditional POD/TOD accounts.

SUMMARY: the primary missing ingredients with POD/TOD planning are (i) the lack of estate aggregation and (ii) the necessary fiduciary control that is otherwise available with a fully funded Revocable Living Trust. There is no substitute for a properly implemented and fully funded Revocable Living Trust estate plan.