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

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.

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.

Whenever considering putting a TOD/POD on a financial account, you must consider the impact doing so will have on your overall estate plan. Therefore, be sure to coordinate any such move with your estate planning attorney to be sure you are not undoing all the excellent planning that has been done to achieve your wishes.

Reference: mondaq (March 15, 2023) “Transfer-on-Death Designations: A Word of Warning”