Many people incorporate a TOD, or “Transfer on Death” into their financial plan, thinking it will be easier for their loved ones because it will avoid probate. They often do this at the suggestion of bankers or financial professionals, and they believe it avoids the need for having a trust or even a will. However, the article “TOD Accounts Versus Revocable Trusts—Which Is Better?” from Kiplinger explains how it really works.
The TOD account allows the account owner to name a beneficiary on an account who receives funds when the account owner dies. The TOD is often used for stocks, brokerage accounts, bonds and other non-retirement accounts, and is akin to having a beneficiary named on the account. It’s worth pointing out that I’m using TOD as a general term here, the specific term might be different for different types of assets. For example, a POD, or “Payable on Death,” account is usually used for bank assets—cash. You can find more information about pitfalls of beneficiary designations here. https://www.galliganmanning.com/common-mistakes-made-on-beneficiary-designations/
The chief goal of a TOD or POD is to avoid probate. The beneficiaries receive assets directly, bypassing probate, keeping the assets out of the estate and transferring them faster than through probate. The beneficiary contacts the financial institution with an original death certificate and proof of identity. The assets are then distributed to the beneficiary. Banks and financial institutions can be a bit exacting about determining identity, but most people have the needed documents.
There are pitfalls. For one thing, the executor of the estate may be empowered by law to seek contributions from POD and TOD beneficiaries to pay for the expenses of administering an estate, estate and final income taxes and any debts or liabilities of the estate. If the beneficiaries do not contribute voluntarily, the executor (or estate administrator) may file a lawsuit against them, holding them personally responsible, to get their contributions.
If the beneficiary has already spent the money, or they are involved in a lawsuit or divorce, turning over the TOD/POD assets may get complicated. Other personal assets may be attached to make up for a shortfall.
Very frequently, naming a TOD/POD beneficiary in an estate that otherwise expects to go through probate (i.e. a will-based estate plan) leads to having non-liquid assets such as a house which cost money to administer, and no money with which to do so.
If the beneficiary is receiving means-tested government benefits, as in the case of an individual with special needs, the TOD/POD assets may put their eligibility for those benefits at risk. This is a very, very common problem when a loved one has a disability.
Very simply too, beneficiaries under TOD/POD accounts can predecease an owner with no meaningful way to handle contingencies. If that happens, the asset will be subject to probate which will negate their advantage, and may not go to the proper beneficiaries. Utilizing trusts can solve that problem.
These and other complications make using a POD/TOD arrangement riskier than expected.
A trust provides more benefit to the trustor (creator of the trust) and in fact can work in conjunction with TODs as part of a complete, integrated plan. Trusts address control of assets upon incapacity because trustees will be in place to manage assets for the trustor’s benefit. With a TOD/POD, a Power of Attorney would be needed to allow the other person to control of the assets. The same banks reluctant to hand over a POD/TOD are even more strict about Powers of Attorney, even denying POAs, if they feel the forms are out-of-date or don’t have the state’s required language. People often don’t think of trusts as part of incapacity planning, but this is often a benefit to a trust-based plan.
Similarly, trusts (whether an asset named the trust as beneficiary of a TOD/POD or if it owns the assets themselves) can address contingencies. So, if a beneficiary has a disability, potential divorce, creditors, predeceases the owner, or virtually any other reason for them not to directly receive money, the trust can provide for what happens under all of those contingencies.
Creating a trust with an experienced estate planning attorney allows you to plan for yourself and your beneficiaries, and if you chose to avoid probate, to do so in a way that will work for all of your assets and to avoid problems created by solely using TOD/POD accounts.
Reference: Kiplinger (Dec. 2, 2021) “TOD Accounts Versus Revocable Trusts—Which Is Better?”