A transfer on death (TOD) designation (also sometimes referred to as payable on death) is a designation that can be added to an account to direct that it be paid to a designated recipient(s) at the death of the account owner. We have been seeing increased interest in this type of designation. While a TOD account can provide many benefits in a coordinated estate plan, it is important to be aware of the potential pitfalls.
To understand the benefits of a TOD account, one must have a general understanding of the probate process in Pennsylvania. When someone dies (the Decedent), the person they name to be in charge of their estate (the Executor) will take the Decedent’s Last Will and Testament to the local county courthouse to present it for validation and to be sworn in as Executor of the estate. This legal process is called probate.
There are two types of assets when administering a Decedent’s estate: 1) probate property and 2) non-probate property. Typically, accounts that are owned in an individual’s name with no other owner or named beneficiary are probate assets that will pass according to the terms of the Decedent’s Last Will and Testament. Examples of probate assets include individually owned bank accounts, investment accounts, and real estate. Non-probate assets are those that pass “automatically” to a new owner by operation of law. The most common examples are retirement accounts and life insurance policies with named beneficiaries and assets titled jointly with rights of survivorship.
Some financial institutions allow for, and even promote, the use of a TOD designation on an account, thereby converting the asset to non-probate property. Providing such a transfer can allow for quicker access to the funds and can help to streamline the transfer of the asset. However, one should be aware of potential unintended consequences.
Because the TOD account does not go through probate, it is not subject to the terms of the Decedent’s Last Will and Testament, it is however still subject to Pennsylvania inheritance tax. As an example, for a Decedent who wishes to leave everything equally to two children, the use of a TOD account naming one child would shift the overall distribution, resulting in one child receiving more than the other. That is because the TOD account will be paid to the named child outside of probate and the remainder of the probate assets will pass equally under the Last Will and Testament.
In addition, one must consider the expenses of an estate. Items such as funeral expenses, taxes, and debts are paid as obligations of the probate estate. If most of the assets are non-probate assets, there may be insufficient funds available to pay estate expenses. If the estate is not paying the expenses, then the tax deductions for those payments are also lost. To take it a step further, if the estate has sufficient assets to cover all expenses but the majority of the Decedent’s assets are non-probate property passing to one child, the burden of the expenses falls disproportionately on the other child and reduces their share of the estate.
Consideration must also be given to what happens if the named beneficiary predeceases the Decedent. Where would the asset go under the TOD designation and what if that beneficiary is a minor? A properly drafted will takes this possibility into account by providing for a succession of beneficiaries and by creating trusts, or other alternatives, for funds that go to a minor beneficiary.
A TOD account can be an effective tool in a coordinated estate plan, but it is important to be intentional about its use. Be sure to review all TOD designations on a regular basis and consult with your legal and financial advisors on the advisability of its use in your particular situation.
If you would like to discuss coordinating TODs with your overall estate planning documents – or creating an estate plan in general – please reach out to attorney Kristen Hartman or any member of Barley Snyder’s Trusts & Estates Practice Group.
