DISPOSITION
OF PROPERTY OUTSIDE PROBATE
A. Overview.
Many arrangements
exist for the transfer of money or property outside
of the probate system. (Such property is said to be
"non-probate" property, and is not part of
the "probate estate.") These arrangements
should be made for convenience and to avoid probate
court - not for state or federal death tax savings,
because there will be no such benefit. The definition
of "estate" for federal tax purposes is
much different from that in probate court.
BEWARE!
A Will has no control at all over any
disposition of property outside probate.
Overlooking this fact is a common and potentially
huge estate planning blunder.
Think of it this
way: Your Will disposes of all property that is NOT
disposed of by some other way. Some of these
"other ways" are mentioned below. All are
familiar and in common use. What these legal
arrangements have in common is that each -
independently - provides for the disposition of
property at or before the death of the owner. In
other words, the terms of these arrangements
themselves dictate who gets the property at the
estate owner's death - not the owner's Will.
Unfortunately,
people just forget that if an asset falls into one of
the below-listed categories, the Will cannot dispose
of it. A Will disposes of only the probate estate. If
that consists of little or nothing, so be it. You had
better be happy with the "out of probate"
dispositions you have put in place. People also
forget that some very common non-probate property
arrangements - like life insurance and retirement
plan beneficiary designations - do not necessarily
become invalid upon divorce, as does a bequest to an
ex-spouse in one's Will.
B. Joint Tenancies
With Right of Survivorship (JROS).
Each of the two or
more "tenants" (owners) has an equal,
undivided interest in the whole account or asset.
Most couples own their house and checking accounts in
this way. By what is called simply, "operation
of law," a decedent's share automatically shifts
to the surviving joint tenant(s) at the very moment
of death. The transfer of ownership is complete at
that point. Nothing the Will says makes any
difference whatsoever, as to this property.
Of course, there is paperwork to be completed before
the account will be switched to the survivor's name
alone.
In almost all
situations, no federal tax is saved
by using joint accounts. For estate tax purposes, 50%
of property held jointly with a spouse is included in
the decedent's estate. If the surviving joint
owner(s) is not the spouse, 100% of
the jointly held property is included in the
decedent's taxable estate, unless the surviving joint
tenant can prove his/her actual contribution to the
account or property.
So, opening a joint account
with an adult child might be a convenient way to
handle business, but it does not save death taxes.
True, upon the parent's death, the account balance
immediately belongs to the child. But the full amount
must still be included in the deceased parent's
taxable estate.
One alternative to
JROS ownership is "tenancy in common." This
is not what most married couples in common law states
have or want, with respect to their marital property.
In this arrangement, each tenant takes a 50% interest
and can sell or bequeath it independently of the
other owner. Community property also can be
bequeathed independently. Tenancy in common is a
frequently seen and appropriate form of ownership in
many situations, as when siblings inherit a piece of
real estate from their parents. Recognize, however,
that discord between the tenants in common could lead
to a sale of one of their shares to an outsider.
F.Y.I. If a Will
says simply, "I leave the following property to
my son and daughter, Jack and Jill," the
property generally passes to them as tenants in
common. The property would not pass to them JROS,
unless specified. (This is fine, as long as that is
what you want.)
C. Qualified
Retirement Plan Benefits and Individual Retirement
Accounts.
This money goes
directly to the beneficiary as you specify when
enrolling in the plan or opening the account,
bypassing probate court. At one time, these funds
enjoyed special treatment, but are now generally
includable in the decedent's estate for tax purposes.
D. Life insurance
Proceeds.
The policy payoff
is part of your private contract with the insurance
company, and it should promptly go to whomever you
direct, with no court involvement. Proceeds from a
policy owned by the decedent to a named person as
beneficiary are excluded from federal income tax, as
well as state income or death taxes in most states.
BEWARE! BUT
if the decedent owns the policy, proceeds are
includable in his federal taxable estate, even though
paid to somebody else. The proceeds are likewise
includable if the policy owner names his
"estate" as beneficiary. The latter
beneficiary designation is also a bad idea because it
exposes the policy proceeds to creditors of the
estate, which would not otherwise happen.
E. Gifts.
One way to avoid
probate of an asset is to transfer it before you
die. If the gift is to young children, you
should be aware of the Uniform Transfers to Minors
Act (UTMA), which is used in most states.
Under this
provision, a gift of money or other property is made
by the donor placing the asset in the name of a
person called the "custodian." It is simply
a matter of titling the asset or account initially,
to show the world that it is held pursuant to the
UTMA. There are no tax returns to be filed. Legal
title is held by the minor, but the custodian manages
the asset until the minor is 21 years old (18 in a
few states), at which time the property is turned
over to the minor.
Until then, the
custodian is required to pay to, or for the benefit
of the minor as much of the property as the custodian
deems advisable for his/her support, benefit,
maintenance and education.
BEWARE!
If these funds are used to pay for basic parental
obligations, this may be considered taxable income to
the parents. The theory is that a taxable benefit
accrues to the parents to the extent they are
relieved of their legal duty of support.
F. Payable On Death
(POD) bank accounts.
The account owner
names a beneficiary (payee) who automatically
receives the account balance on the death of the
owner. Until then, the beneficiary has no rights in
the account, since the beneficiary can be changed or
the account closed. Many states (with more surely to
come) have also adopted a Transfer on Death (TOD) law
pertaining to shares of stock and bonds that works
the same as the POD arrangement does for bank
accounts. Note that these designations might offer
time-savings and convenience, but neither of them
saves any tax.
The information contained in these
pages is not intended
to be legal advice, and does not create an
attorney-client relationship. You should
always consult with an attorney before taking
any action.
