Part IV: Property Ownership, Titling and Beneficiaries
Most people have the misunderstanding that it's their will that dictates how property is distributed at their death. In fact, their will doesn't even come into play until after all possible property is distributed by ownership designation and beneficiary arrangements. For example, someone who thoughtlessly left her ex-husband as beneficiary on her 401k plan – regardless of what her will said – would see (from the great beyond, of course) ALL of her 401k plan go to that good-for-nothing ex-husband who owed her seven years of child support. The federal government greatly simplified the rules for beneficiary designations a few years ago, but they are still a critical part of estate planning.
Titling How property is titled will determine: whether it is part of the probate estate; whether it is subject to creditors; whether the terms of the will would apply at death; and whether it receives a step-up in basis at death. Titling must be done very carefully so as to accomplish the desired objectives in the estate plan. One advantage of community property, for example, is that both halves receive a step-up in basis at the death of the first spouse. With joint tenancy and tenancy by the entirety, only half the property gets a step-up, regardless of each spouse's contribution.
Fee simple property is wholly owned by an individual, and at death becomes part of the probate estate.
Joint Tenancy with Rights of Survivorship (JTWROS) offers convenience at death, in that by "operation of law" it passes directly to the survivor(s). However, it is inflexible, may expose assets to creditors, and removes the chance to use trusts that may enable more flexible distribution and reduce taxes. Property is divided equally regardless of the owners' original contributions, and will pass automatically (and outside of probate) to the joint tenants at the death of any of them.
Tenancy-in-common offers flexibility in ownership but all of it passes through probate, with the deceased's share becoming part of his estate and distributed according to his will (or applicable intestacy laws). There is no right of survivorship. This would be used for any co-owners whose shares are unequal, non-spouses, and most commercial property.
Tenancy-in-the-entirety is very much like JTWROS, but is available only to married couples (and sometimes domestic partners), and is not available at all in community property states. It can provide protection to one spouse when the other has problems with creditors or even bankruptcy – but the entire property will be exposed if the non-debtor spouse dies first. Unlike JTWROS, it cannot be severed without the agreement of both parties.
Transfer-on-death (TOD) designations will automatically transfer property (except real property) on death. These were once known as Totten trusts, Payable-on-death (POD), or In-trust-for (ITF) accounts, and are common in banks. They may now be used for non-qualified investment accounts as well, where there would normally be no ability to name a beneficary. Assets held in a TOD account are subject to creditors claims, and will pass outside of probate.
Community property There are eight community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas and Washington), and two others (Wisconsin and Alaska) that enable some community property designations; in these states, each spouse is entitled to a one-half interest in any property acquired by either spouse during the marriage – unless it was owned prior to the marriage, inherited or gifted, in which case it's considered "separate property."
These rules affect estate taxation, life insurance proceeds, and many other issues – and they're important to know even if you live in one of the other forty "common law" states: people are very mobile these days, and community property retains its character unless expressly changed. Many states (through the Uniform Disposition of Community Property Rights at Death Act) recognize community property that's been used to purchase real property as retaining its character at death as well.
The fact that there are essentially two different legal systems pertaining to marital property can raise many issues that financial planners must discuss with clients.
Lastly, a living trust is another way to avoid probate, and can be especially useful when real property is owned in multiple states to avoid the need for separate probate proceedings in each state. It also offers the advantage of privacy, since otherwise assets may be subject to the public process of probate. However, in some cases the living trust is a tool that is oversold by attorneys, who successfully but needlessly worry clients about the expense and difficulty of probate. In effect it can be like pre-paying probate costs, since the client may be charged thousands to establish it.
In any case, if a living trust is used the attorney and financial planner need to make sure that all assets that need to be are properly retitled to the trust; otherwise, it is a uselessly empty device at death.
There are other tax and gift implications to much of the above, but this should give you some idea of the importance and complexity of titling in an estate plan, and the need to use both an attorney and a Certified Financial Planner™ professional in putting it together.
Estate Planning Continued: Part I, Part II, Part III, Part IV, Part IV
FPA member Tim Sobolewski, CFP®, is President of The Financial Planning Center, Amherst, N.Y.