Transfer-on-Death Designations: A Word of Warning

Although transfer-on-death (TOD) and payable-on-death (POD) designations on financial accounts can be an effective tool to avoid the probate process, these account designations have the potential to derail a customer’s estate plan when not coordinated properly with the overall plan. Prior to making a TOD/POD designation, customers should be cautioned about the potential pitfalls of doing so and advised to consult with an estate planning attorney to avoid unwanted results.

A primary benefit of using TOD/POD designations is that assets held in the account will pass automatically to the beneficiary without having to go through probate. This benefits both the beneficiary and the financial institution administering the account, as both parties avoid the unnecessary delays and administrative oversight involved in the probate process. Designating a beneficiary on a TOD/POD account is typically simple and easy, and in fact many financial institutions ask account owners to name a beneficiary when a new account is opened.

However, TOD/POD designations can derail a customer’s estate plan in numerous ways:

• TOD/POD designations remove assets from the probate estate: Estate planning documents operate only on assets that pass through probate or are otherwise directed to a revocable trust. If family members or trusts are included in an estate plan but TOD/POD designations direct most of a decedent’s assets elsewhere, the provisions of the estate plan will not be implemented. However, when thoughtfully prepared in consultation with an estate planning attorney, TOD/POD designations can be used effectively in conjunction with an estate plan to avoid probate while ensuring that the provisions of a revocable trust are still operative, such as by naming the trust as the beneficiary.
• TOD/POD designations affect tax-efficient planning and planning using trusts: When an estate plan includes sophisticated tax planning — such as the use of credit shelter trusts, marital trusts, and/or generation-skipping transfer (GST) trusts — a TOD/POD designation could prevent the implementation of these tax-planning strategies. For example, if an estate plan provides for the creation of a GST trust but the decedent’s financial account has a TOD/POD designation in place naming individuals, the assets will not pass to the intended trust(s) under the terms of the estate plan. In addition to directing assets in a way that contradicts an estate plan, such a mistake can result in unused tax exemption(s).
• TOD/POD designations can create liquidity problems in an estate: If all or substantially all of an individual’s financial accounts pass by TOD/POD designations, leaving only illiquid assets such as real estate or closely held business interests in the estate, there may not be sufficient cash held in the estate to pay estate expenses and any federal or state estate tax that might be due. In such a case, the personal representative might need to recover necessary funds from the beneficiaries of an account with TOD/POD designations.
• TOD/POD designations can undermine changes made to an estate plan: As circumstances change, people often wish to reconsider their estate planning goals. It is easy to forget to update TOD/POD designations at the same time, especially if one’s estate planning attorney is not aware of such designations. This inadvertent omission increases the risk that a customer’s wishes will not be carried out upon death.

Whenever a customer is considering putting a TOD/POD designation on a major financial account, the customer should be warned that the designation may have unintended effects on his or her overall estate plan. As such, it should be made clear that the customer is not required to make a TOD/POD designation, and the customer should be advised to consult with his or her estate planning attorney to discuss how such designation should be integrated with his or her estate plan.