Naming Beneficiaries On Financial Accounts: Advantages And Disadvantages

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More and more, people are being advised to add “transfer on death” designations to their non-IRA brokerage assets. This increasingly popular tool has both benefits as well as detractions and is best used only in certain circumstances.

Our alert below provides an overview of the designations and explores how and when they can be used most effectively.

Why Do Some Advisors Recommend “Transfer on Death” or “TOD” Designations?

Many clients believe that “avoiding probate” is a noble goal and ask their advisors how to avoid it. By naming a beneficiary on a particular asset, that asset is available to that beneficiary as soon as a death certificate is issued. The collection of that asset is not subject to the delays that can accompany the probate of a will. The beneficiary can have immediate assets available.

A client with a non-retirement brokerage account can name a beneficiary or beneficiaries of the account and thereby allow the account to pass outside the clients will. There is no need to wait for the will to be probated to collect that asset. The asset will simply “transfer on death” to the named beneficiaries upon the presenting of a death certificate by the beneficiaries. However, such designations may wreak havoc with the client’s existing estate plan as it is mapped out in their will or revocable trust.

What are the Concerns with a “Transfer on Death” Designation?

As trusts and estates attorneys, we usually recommend naming a beneficiary on an IRA or other retirement account. However, naming a beneficiary on a non-retirement asset account can often destroy a well-constructed estate plan. Although such a designation may be a good idea for some clients’ accounts, it is not recommended for others.

Once an account is designated to transfer on death to a named beneficiary, it is not available to satisfy bequests under a will, for example, cash bequests. It is also not available to pay the decedent’s funeral bill, debts including taxes, administration expenses of an estate (court filing fees, attorney, accountant and appraiser fees, among others) unless there are other assets passing under a will to satisfy such expenses and cash bequests. The assets passing under the will may not be liquid and the executor may be forced to sell assets such as real estate to pay for such expenses. This would be true whether someone used a will or a revocable trust to pass on assets on death.

If the client has other liquid assets and the designation of one or two accounts makes sense in the overall estate plan, a TOD designation may be advisable. However,a holder of such an account should not name a beneficiary unless they are sure that the change makes sense in light of an overall plan.

Case Study: Clare’s Will

To provide a theoretical example, we can take a look at Clare’s will and how her assets are divided upon her death. Clare is single and lives with her sister Danielle a home owned by Clare. Clare has a will under which she bequeaths $30,000 to each of Clare’s three nieces and two nephews that survive Clare. Clare leaves the balance of her estate to Danielle. Clare’s estate consists of a brokerage account with assets of $500,000, a checking account with $15,000 and a home worth $450,000. If nothing changes, then the brokerage account will be available to satisfy the bequests of $150,000 to the nieces and nephews. After payment of Clare’s funeral bill, debts, income or inheritance taxes owed and estate administration expenses, the executor can transfer the balance of the estate, also known as the “residuary” (which presumably includes the home) to Clare’s sister, Danielle.

Without consulting with her attorney, Clare named all the nieces and nephews as beneficiaries of the brokerage account with a “transfer on death” designation. Upon Clare’s death, the brokerage passes to the five nieces and nephews. Because Clare did not change her will, the bequests of $30,000 remain under the will. The nieces and nephews are still entitled to those bequests. Clare’s best friend is the named executor,and she has no choice but to sell the home that Clare and her sister lived in to raise cash to satisfy the bequests. Clearly, this is not the result intended by Clare. Her sister will inherit the residuary estate but will not have the home to reside in any longer.

History of TODs

New York State adopted the Uniform Transfer on Death Security Registration Act in 2005, (see EPTL Article 13 Part 4) but if a registering entity or its transfer agent had a principal office in a state that adopted the Act before 2005, account owners (regardless of their domicile) could have made use of a TOD designation. Wisconsin was the first state to adopt the Act in 1990 and many states soon followed. The only state today that has not enacted the Act is Louisiana but a bill was introduced to the state legislature in May 2020.

When to Use TODs

TOD designations have worked well to avoid probate when assets are to be distributed to a surviving spouse or an only child, as well as in cases where the account is not a substantial share of the estate. Clients with more complicated plans or assets should seek advice of all their attorneys before naming a beneficiary on an account.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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