Non-probate property vs. probate property

Non-probate property is that property which passes automatically to another person by operation of law, without the need for a Will to designate how the decedent’s property should pass. Typical non-probate property includes: property held by a trust, which has designated beneficiaries who receive the property at a specified time; property subject to a community property agreement, which usually specifies that the surviving spouse will receive all community property; any property held in joint tenancy with right of survivorship, which passes to the other joint tenants upon the death of any of them; and any property that has a designated beneficiary upon the death of the owner, such as payable on death bank accounts, transferable-on-death securities, life insurance, and retirement accounts. There is no requirement for a probate for these types of property because they pass to the beneficiary(s) automatically by prior legal agreement or the characterization of the property.

Probate property is all property that is not non-probate property. Probate property is not subject to a prior legal agreement for its passage at one’s death. Probate property includes: property held in the deceased’s name only; property held by a married couple, and not subject to a community property agreement or held as joint tenants; any property held with others as tenants in common; and any property payable to the deceased’s estate at his or her death. Probate property passes under the supervision of the court through the probate process and is generally ordered to be passed subject to the terms of a Will.

Revocable Living Trusts

A Revocable Living Trust (also known as a Family Trust or Living Trust) is used primarily to avoid probate, reduce estate taxes, preserve your privacy and manage your financial affairs.

A Revocable Living Trust is a trust established while you are living. It is revocable, so you are able to make changes whenever you want, as well as reclaim the property transferred into it. It describes how your property should be managed while you are alive, and how it should be distributed upon your death.

Normally, if a person without a trust dies, there must be a probate process to determine how to distribute all of the property held solely in the decedent’s name. A Will can help the probate court to determine where the property should go, but does not avoid the probate process. In fact, one primary purpose of probate is to validate a Will if one exists. Probate is a public procedure and opens up an estate’s distribution to the public eye.

When you have correctly set up and used a Revocable Living Trust, upon your death there will be no probate process. This is because the owner of the property (the Trust) did not die; just the person in the role of the grantor and trustee (you). The new successor trustee will be able to take over without the probate process.

By itself, a revocable living trust does not avoid income, estate or gift taxes. Standard provisions for saving estate and gift taxes can be included in a revocable living trust or a Will. You should not set up a revocable living trust just to save taxes.

The exact cost of a revocable living trust depends on how valuable and complicated your assets are, whether standard documents can be used, how many assets must be transferred to the trustee and whether tax planning is needed.

If you do not plan to serve as trustee, you should consider any fees you might have to pay the trustee and whether those fees would replace fees you are already paying to manage your assets. A standard revocable living trust package should include the trust document, the transfer of assets to the trust, a “pour-over” Will to add any other assets to the trust, and a certificate of trust.

Joint tenancy with right of survivorship

Joint Tenancy with Right of Survivorship provides for ownership of property by two or more people or entities in which the survivor(s) automatically gain ownership of the decedent’s interest in the property. The individuals or entities, who are called joint tenants, share equal ownership of the property and have the equal, undivided right to keep or dispose of the property. Joint tenants usually share ownership of land, but the property may instead be money, stocks, financial accounts, or other items.

To establish ownership, the surviving individual typically only has to present a death certificate to the financial institution holding the property or record the death certificate in the County where the real property is located.

The biggest pro to a Joint Tenancy is the fact that ownership of the property is transferred outside of probate. This makes this type of transfer simple and economical. During the life of the tenancy, the creditors of all of the tenants can reach each tenants’ share of the property.

Paid on death accounts and transfer on death accounts

A Payable On Death bank account is a regular bank account that names a specific person or persons as the beneficiary(s) of all funds once the bank account holder dies. All you have to do to set up a Payable On Death bank account is notify the bank of the legal name of the person(s) who you want to inherit the funds. In just one step, you avoid probate as to that asset and ensure that the person designated will receive the money upon your death.

With a Payable On Death bank account, the beneficiary has no rights to the funds until you pass on. Until that time, you are free to use the money kept in the bank account, to change the beneficiary, or to close the account. You control everything until you pass on, which leaves many people with peace of mind.

The only real drawback to a Payable On Death bank account is that you cannot name alternate beneficiaries on one account. This can easily be overcome by setting up multiple Payable On Death bank accounts for different beneficiaries, such as three or four children.

The beneficiary should have no problems when claiming the funds on the Payable On Death bank account. As long as the beneficiary can prove that you have passed on, the money stored in the bank account will be given to that person or transferred to his or her bank account.

Almost every state has adopted a law (the Uniform Transfer-on-Death Securities Registration Act) that lets you name someone to inherit your stocks, bonds or brokerage accounts without probate. It works very much like a payable on death bank account. When you register your ownership, either with the stockbroker or the company itself, you make a request to take ownership in what’s called “beneficiary form.” When the papers that show your ownership are issued, they will also show the name of your beneficiary.

After you have registered ownership this way, the beneficiary has no rights to the stock as long as you are alive. But after your death, the beneficiary can claim the securities without probate, simply by providing proof of death and some identification to the broker or transfer agent (a transfer agent is a business that is authorized by a corporation to transfer ownership of its stock from one person to another).

Life insurance beneficiary designations

A beneficiary is the person or entity you name (designate) to receive the death benefits of a life insurance policy. The beneficiary can be either irrevocable or revocable. Once named, you cannot change an irrevocable beneficiary without his or her consent. A revocable beneficiary can be changed by you at any time.

You can name as many beneficiaries as you want, subject to procedures set in the policy. The beneficiary(s) to whom the proceeds go first is called the primary beneficiary(s). Secondary beneficiaries are entitled to the proceeds only if they survive both you and the primary beneficiary(s).

You should name secondary beneficiaries. You may outlive the primary beneficiary(s), you may die simultaneously, or the primary beneficiary(s) may be unable to collect the proceeds. In these cases, if you have not named secondary beneficiaries, the proceeds pass to your estate and therefore go through probate. Proceeds paid to your estate are subject to all the expenses, creditor claims, and delays associated with settling an estate, whereas named beneficiaries can receive proceeds almost immediately after your death and free of your creditors.

Retirement account beneficiary designations

A major issue in estate planning is who to name as beneficiaries on pension plan accounts, IRAs, Keoghs and 401(k)s. Often this important decision is given too little consideration. However, naming beneficiaries can be complicated and can present estate and income tax consequences to the beneficiary.

When naming beneficiaries, remember to consider:

  • Age of beneficiary - Many policies and plans will not directly transfer assets to minors until a trustee or guardian is approved by a court or you name a custodian to hold the retirement account on behalf of the minor.
  • Ability of beneficiary to manage assets - Perhaps a trust set up in the person’s name would be more appropriate than a direct transfer.
  • Pension plans - Unless waived by the spouse in writing, generally the law requires a spouse to be the primary beneficiary of the account.
  • Naming contingent beneficiaries - Should something happen to your primary beneficiary; the contingent beneficiary would receive your assets.
  • Naming a Trustee of a Trust as a Beneficiary - It can be an effective estate-planning tool for people to name a trustee of a trust as the beneficiary. The use of a trust can be used to avoid estate taxes or protect beneficiaries, such as children who are too young to manage the money themselves, or adult children with special needs. The trust must be written to follow strict IRS guidelines known by estate planners as “see-through” or “conduit” trust rules. Also, the income-tax rates that trusts pay are generally higher than income taxes paid by individuals. The trustee can avoid paying the higher trust rate if the trustee can pass all the IRA distributions out to the individual trust beneficiaries.

A. Employer-Sponsored Retirement Plans

For married individuals, the law requires that a spouse be the primary beneficiary of an employer-sponsored retirement plan unless he or she waives that right in writing. A waiver may make sense in the case of a second marriage if a current spouse is financially independent or if family members from a first marriage are more likely to need the money.

When retirement plan assets are left intact within an estate, spousal beneficiaries may inherit the money without paying federal estate or income taxes. After age 70½, the surviving spouse must begin required minimum distributions (RMDs) based on his or her life expectancy. The RMDs are taxed as ordinary income. This withdrawal schedule typically is preferred to cashing out the entire bequest at once, which is likely to trigger higher tax payments.

Prior to 2007, non-spousal beneficiaries (children, siblings, unmarried partners, and others) were required to cash out retirement plan bequests between one and five years after the account owner’s death. After 2007, employer-sponsored plans are permitted to offer non-spousal beneficiaries the option of completing a trustee-to-trustee transfer from an employer-sponsored plan to an IRA established for this purpose and taking annual distributions based on the beneficiary’s life expectancy. Note that some plans have not amended their rules to permit trustee-to-trustee transfers and continue to require non-spousal beneficiaries to follow the five-year rule.

Before taking any action, it is critical that non-spousal beneficiaries determine the rules of the retirement plan in question and also consult a financial advisor with experience in this area. An advisor can ensure an inherited IRA is titled properly, thereby avoiding unnecessary tax payments.

B. Individual Retirement Accounts

With an IRA, spousal beneficiaries may designate themselves as the account owner and treat an inherited IRA as their own. This means a surviving spouse can transfer the assets to an existing IRA or to an employer-sponsored plan. These transfers typically do not trigger tax payments as long as a spouse follows rules for trustee-to-trustee transfers. After age 70½, a spousal beneficiary is mandated to take annual RMDs, which are based on the surviving spouse’s life expectancy and are taxed as ordinary income.

Non-spousal beneficiaries cannot transfer assets within an inherited IRA to an existing IRA. Instead, they have two options: they may take all distributions within five years of the original account owner’s death or take annual distributions determined by the life expectancy of either the beneficiary or the decedent, whichever is longer.