Reasons Not to Use ToD/PoD Beneficiary Designations — Oblivious Investor

At death, several types of assets do not have to go through probate. Instead, they pass directly to one or more named beneficiaries. This includes things such as retirement accounts, insurance policies, and assets held in trust. It also includes any assets titled as “payable on death” or “transfer on death.”

Having assets pass outside of probate can save time/hassle, as well as money. (Note: how long probate takes, as well as how much it costs, varies meaningfully by state. Go get the applicable details for yourself before making decisions based on a desire to have assets pass outside of probate.)

When many people learn about the simpler nature of assets passing via ToD/PoD designations, they put such designations on as many of their assets as possible. And in some cases, that does indeed make perfect sense.

But there can also be ways for ToD/PoD designations to backfire.

Not Enough Assets for the Estate to Pay Its Bills

One way in which ToD/PoD designations can backfire is that they can create a situation in which the estate is left with insufficient assets to pay its own bills and “preresiduary bequests.” (In a case in which the will states, “I leave $50,000 to my brother and the remainder of the estate to my daughter,” the bequest to the daughter is a residuary bequest — a bequest of the residual balance — and the bequest to the brother is a preresiduary bequest.)

Ideally, the estate should be left with enough assets to pay preresiduary bequests, the estate’s various tax liabilities (income tax, estate tax if applicable, and property tax), burial/cremation/funeral costs, tax preparation fees, fees to anybody administering the estate, and whatever other expenses the estate is likely to incur. Otherwise disputes may occur, and those disputes may cause permanent damage to family relationships.

Example: Gina’s will indicates that $20,000 is to be left to each of her three nieces, and the remainder of the estate is to be divided between her two children. If too large a portion of Gina’s assets pass via ToD/PoD designations to her two kids, the estate won’t have the $60,000 to pay the intended bequests to her nieces.

Assets Going to the Wrong Person

In some cases, people forget about the ToD/PoD designation on a particular account and thereby end up making decisions that circumvent their own intentions.

Example: Clara’s will indicates that her estate is to be divided equally among her son and two daughters. Clara’s son lives in town with her and is involved in helping her with various day-to-day concerns, whereas her two daughters live elsewhere. Clara has a bank account that represents about 5% of her total assets. The account is payable on death to her son, with the idea being that he’ll ultimately get somewhat more than his siblings, because of the additional help he has provided.

Later in life, Clara sells her home and begins renting a smaller apartment. The proceeds from the sale end up in her bank account and are never redeployed elsewhere. When Clara dies, the bank account represents more than half of her total assets, and her son ends up inheriting a much greater percentage than she had intended.

ToD/PoD designations may cause similar problems in which one of the designated beneficiaries predeceases the original owner (i.e., the assets are ultimately split in a way that is not in keeping with the original owner’s wishes).

Circumventing a Trust

It’s common for an estate plan to involve leaving assets to beneficiaries in trust (i.e., rather than leaving the assets outright, they are left to a trust for the benefit of the person in question). That’s often done for the sake of creditor protection (because the assets in the trust would not be available in a lawsuit against the beneficiary, whereas assets left outright to that person would be). Sometimes it’s done to prevent the assets from being lost to a spouse in a divorce. And sometimes it’s done for estate tax planning reasons (e.g., so that the assets in the trust are not in the beneficiary’s own estate when he/she dies).

Unfortunately, it’s also common for people to pay an attorney to prepare a thoughtful estate plan which includes one or more trusts, and then (without discussing with the attorney) they designate PoD/ToD beneficiaries on accounts rather than leaving the assets to the trust(s) as intended in the estate plan.

Make Sure It’s a Cohesive Plan

Transfer on death and payable on death designations can be helpful. In the right cases, they can avoid considerable hassle and sometimes financial costs as well. But as with any aspect of an estate plan, such designations should be:

• Carefully thought through before being made,
• Considered in light of the overall estate plan, and
• Revisited regularly or whenever the household experiences a major change in circumstances.

Among people who read personal finance books, many save a high percentage of their income through most of their careers. One thing that eventually happens for some such people is that they reach a point at which they realize they have not only saved “enough,” they have saved “more than enough.” Their desired standard of living in retirement is well secured, and it’s likely that a major part of the portfolio is eventually going to be left to loved ones and/or charity. And that realization raises a whole list of new questions and concerns.

This book’s goal is to help you answer those questions.