Probate (#*@$%!): Misconceptions, Pros, and Cons

Authors: Jeffrey D. Scibetta and Boutros Imad

Originally published in October 2023

Copyright © 2023 Knox McLaughlin Gornall & Sennett, P.C.

This article has not been updated for current law since the date of its posting on the website. This article is not intended to provide any legal advice. Please seek advice of your professional council.

Any U.S. federal and state tax advice contained in this communication is not intended or written by the Knox Law Firm to be used, and cannot be used by you, for the purpose of: (i) avoiding penalties under the Internal Revenue Code that may be imposed upon you, or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

The Probate Process

Definition of Probate: What is “Probate”? Probate is a term that is used to mean different things, depending upon the context in which it is used. People will often refer to “probating” a Will, which essentially means the process by which an individual’s Will is authenticated as his/her valid and final Will. However, the term “probate” is also used more generally to refer to the entire process by which an estate is administered through the court system. So an individual’s “probate” assets generally refer to those that make up his/her estate for administration purposes, and “non-probate” assets typically refer to those assets (such as, for example, jointly held assets and IRAs) that are passed on to recipients outside the estate administration process.

Purpose of Probate. The probate process is basically intended to make sure that a decedent’s assets are administered properly, meaning, among other things, that the decedent’s obligations (including both those debts that predated the decedent’s death and the costs of administering the decedent’s estate) are paid, as required by law and in the proper order of priority, and that any remaining assets in the estate pass to the proper persons and in the amounts to which those persons are entitled. Another way of thinking of it is that probate is a process that is designed to make sure that the fiduciary (e.g. Executor) is doing all of the things he/she is supposed to do, and that everyone (including creditors, beneficiaries and/or heirs) gets what they are entitled to.

Steps involved. Like many processes, “probate” (estate administration) involves various steps, many of which are ministerial, some of which are more significant. In a broad sense, it involves:

• Gathering (and in some cases selling) the decedent’s assets;
• Paying the decedent’s debts and expenses;
• Preparing, filing and paying the decedent’s taxes (both income and inheritance);
• Accounting for the estate’s activity (receipts, disbursements, gains and losses) during the period it is being administered; and
• Distributing the remaining assets to the beneficiaries (or heirs).

How the Probate Process differs in different states. Within the United States, the probate process differs from state-to-state. Each state prescribes its own rules for administering an estate. Although there is a significant degree of similarity from state-to-state, individual states can vary in important particulars. For example, some states generally require a hearing in order to open an estate, whereas others allow an estate to be opened without a hearing unless an interested party contests the Will or the opening of the estate. Some states also require court approval to sell an estate asset (e.g., sales for more than a stated threshold), whereas other states do not require court approval unless an estate asset is being purchased by an interested party such as the Executor. In general, some states have more formal, rigid rules for administration and others have more relaxed, flexible rules for administering estates. Pennsylvania’s rules for estate administration are generally quite flexible and require minimal involvement by the court under ordinary circumstances.

Misconceptions About Probate

Privacy. One of the stated rationales for circumventing probate is that it supposedly affords greater privacy. The notion is that if there is no estate administration, then there is no public record for nosy neighbors or others to comb through, and so those persons will not be able to find out about the decedent’s financial affairs. However, the idea that probate avoidance results in greater privacy is exaggerated in at least two important respects. First, if an Inheritance Tax Return is required, then the filing of that return will be a matter of public record, and so a truly enterprising individual could find out about a decedent’s financial information (assets, debts, etc.) by going to the courthouse and examining the return. Second, in the writer’s experience, far fewer persons are willing to go to the trouble to find out about deceased persons’ finances than is sometimes thought.

Rigidity. Another rationale for probate avoidance is to avoid perceived rigidity associated with an estate administration. It is not uncommon to hear clients state their concern that the decedent’s assets will be “locked up” during the estate administration. However, that concern is often greatly overstated. At least in those estates that have sufficient liquidity, it is not uncommon for an executor to make advances (earlier distributions) to beneficiaries. The executor does so at his/her own risk, and so best practice is to be conservative in making such distributions, but the larger point is that an executor often has more flexibility in administering an estate than is commonly realized.

Costliness. Another understandable concern is the cost associated with probate. It is, however, not invariably the case that avoiding probate will save costs. In certain circumstances, it can – it depends on the particular circumstances and the specific manner in which probate is avoided. However, in other circumstances, it makes very little difference and can even increase costs.

Delays. Some clients perceive that by avoiding probate, they avoid delays and expedite completion of the process. However, at least in Pennsylvania, in most cases the completion of an estate administration is triggered by the filing and approval of the Inheritance Tax Return. Probate has no bearing on a decedent’s Inheritance Tax obligation. So probate in most cases has limited bearing on the prudent and appropriate time frame for distributing a decedent’s assets to beneficiaries.

Common Ways to Avoid Probate

1. Revocable Trusts / Living Trusts
2. Jointly Owned Accounts
3. Beneficiary Designated Accounts

"LIVING" TRUSTS / REVOCABLE TRUSTS

What is a “living trust”? Literally, a “living” trust is any trust created during the Settlor’s lifetime. However, from a practical standpoint, the term “living trust” is most often used to refer to a revocable trust, i.e., a trust by a settlor during his/her lifetime, which is, by its terms, amendable or revocable by the settlor at any time while the Settlor is still alive.

How a (revocable) living trust works. A revocable trust operates in much the same way as a Will, except the trust governs only those assets that have been transferred (re-titled) into name of the trust. Because a living trust only covers trust assets, it is common practice to also have a “pour-over” Will drafted that governs the disposition of any assets not already titled in the name of the trust. This is essentially a Will that states that the testator’s residuary estate (remaining assets) is/are to be transferred at the testator’s death over to the trustee of the living trust. In this way, the living trust acts as the principal dispositive document affecting the disposition of the decedent’s assets.

Rationale for “Living Trusts”. A revocable trust arrangement ordinarily costs more (not less) to establish. That is because (a) there are more documents to prepare and (b) additional work is also needed to re-title assets into the trust. The rationale for such arrangements is that they supposedly save money on the “back end” in the form of lower administration costs when the settlor dies.

COMMON MISCONCEPTIONS ABOUT LIVING TRUSTS

Tax Savings. Some persons believe (and, in some cases, they have been lead to believe) that living trusts can be used to reduce a person’s estate or inheritance tax exposure. Simply put, revocable trusts do not have any bearing on federal estate tax or on Pennsylvania inheritance tax. The assets in the trust will be subject to tax in the same manner as any other assets the person owns.

Costs Savings (Administrative Costs). Another perceived advantage of revocable trusts is that they reduce the costs of administration. The notion is that by transferring assets into the trust, the settlor reduces size of his/her probate estate, and thereby reduces estate administration costs. That can sometimes be true if, for example, the legal fee for the estate administration is calculated as a percentage of the estate’s probate assets. However, it tends to be less true (and sometimes not true at all) if the fees for the estate administrations are based on hourly time charges. In fact, in more complex estate/trust administrations, the revocable trust format can often complicate matters and can therefore actually cause the administration to be more expensive than it would have been under an ordinary Will.

Simplicity. A related notion is that use of a revocable trust will simplify the administration of an individual’s estate. That can sometimes be true if, for example, the decedent has only liquid investments or where there is only a single beneficiary involved. However, use of a revocable trust can just as often complicate an estate administration.

Example #1: Individual “A” has significant assets, some of which he transfers into a revocable trust, and some of which he retains in his own name. At individual A’s death, there will ordinarily be at least two (2) separate fiduciary filings – one for his estate and the other for his living trust which, by definition, becomes an irrevocable, taxpaying entity at his death. (Note that a tax election can be made at the federal level to report the trust assets on the estate fiduciary return, but such an election does not exist at the state level in Pennsylvania.)

Privacy. Another touted advantage of living trusts is they afford greater privacy concerning a person’s financial affairs. This point was already discussed earlier. It is true that assets that have already been transferred into a revocable trust during a person’s lifetime are not part of his/her probate estate, and therefore those assets do not need to be listed on the Inventory of estate assets that must be filed with the Register of Wills Office. However, the assets would still need to be reported on the inheritance tax return, which is filed in the very same place (Register of Wills Office). So the reality is that when you die, assets that you own or effectively control (as trustee of a revocable trust) become a matter of public record one way or another. It is impossible to absolutely guarantee permanent and total privacy concerning one’s financial situation.

Avoiding Delays. Finally, another perceived advantage of revocable trusts is that they expedite settlement and distribution of any entrusted assets. For many estates, however, the largest single cost is inheritance tax, and – as already discussed – use of a revocable trust does not affect inheritance tax. So, when assets are part of an estate administration or are held in trust, the fiduciary will normally not be in a position to distribute the bulk of the assets until the inheritance tax obligation has been paid and approved by the Department of Revenue.

SITUATIONS WHERE LIVING TRUSTS CAN BE HELPFUL

While the advantages of living trusts are frequently exaggerated and/or oversold, living trusts can nevertheless still be useful in certain situations. Some examples include:

States with high probate costs. Probate procedures and the costs associated with an estate administration vary significantly from state-to-state. In those states where the probate procedures are more cumbersome and/or the filing fees and other costs of probate are particularly high, living trusts typically make more sense and are therefore more commonly used as a means to pass wealth between generations.

Properties listed in multiples states. Another circumstance where living trusts can be useful is where an individual owns real estate in multiple states. If a deceased individual owned land in different jurisdictions, the ownership of such properties will normally necessitate opening an estate in each of those different states. As multiple estate administrations can multiply the costs of administering the various assets, this is often a result to be avoided. One way to avoid having multiple ancillary estate administrations can be to consolidate all of the various properties inside a single trust, and to provide in the trust agreement a particular state which will be considered the situs of all the trust assets.

Settlor’s Incapacity. Unlike a Will, a revocable trust agreement can (and often does) contain provisions that set forth procedures and a plan of succession in the event that the settlor becomes incapacitated. An individual’s incapacity can also be addressed in a power of attorney. However, a power of attorney ordinarily entails ceding significant control over to the designated Agent. With the revocable trust document, the settlor could limit the authority of the designated successor to those assets that have been transferred to the trust.

Succession. Financial institutions are generally less apt to raise questions about a successor trustee’s authority to act than they are with respect to a designated Agent under a power of attorney.

Second Marriages. Revocable trust agreements can sometimes be used as a tool to help “lock in” an estate plan in the context of a second marriage.

PROBLEMS / DISADVANTAGES WITH LIVING TRUSTS

Upfront Costs. As already noted, an estate plan that utilizes living trusts generally costs more for a few different reasons: (1) The need to draft additional documents (including a “pour-over” Will and the revocable trust agreement); and (2) the re-titling of assets into the name of the trust.

Funding Issues. Once the decision is made to utilize a revocable trust, the next question is what to put into the trust. The question of funding can be problematic in several respects:

Underfunding. First, if the trust is under-funded, a lot of the putative benefits of the revocable trust are lost, because to the extent that a probate estate remains, there is still an estate to administer when the settlor/testator dies.

Overfunding. Second, if the trust is over-funded and the trust agreement does not contain certain provisions, then that too can cause problems. For example, if a settlor moves all of his assets into a revocable trust, and if the trustee (or successor trustee) of the trust is a person other than the executor, problems can arise if the tax payment provisions in the Will are not drafted in a way that properly ties together with the estate administration.

Loss of Medicaid exemption for residence. Another important thing to consider is the impact of asset titling on an individual’s ability to qualify for certain resource-based forms of public assistance, such as Medicaid. For individuals applying for Medicaid, the personal residence is generally a “non-countable” resource (exempt asset) – in other words, it is not counted toward (does not adversely affect) an individual’s eligibility for Medicaid. However, if an individual owns their personal residence indirectly as settlor/beneficiary of a revocable trust, then the individual’s interest in the trust (which in turns owns the residence) is treated as a countable resource that is counted against the individual in determining whether he/she qualifies for Medicaid.

Administrative Costs. As noted earlier, revocable trusts can lower the costs of administration when the settlor dies, under certain circumstances. However, from experience, it is submitted that those circumstances where the use of a revocable trust lowers administration costs are significantly narrower than is commonly perceived. More often, revocable trusts have no bearing on the costs of the administration or even increase the costs of administering a decedent’s assets. This can occur for a number of different reasons:

If the trust is only partially funded, the use of the revocable trust results in two separate administrations, potentially necessitating additional court filings.

If the trust is fully funded (all assets titled in the trust), then the estate may have insufficient assets to pay the inheritance tax attributable to the entrusted assets.

Depending on what tax elections are made, it may be necessary to file multiples sets of fiduciary returns – one for the estate and the other for the trust itself. Also, even if an election is made (under IRC §645) to report the trust’s income and expenses on the estate fiduciary return for federal tax purposes, that election does not exist at the state level in Pennsylvania. It is still necessary to prepare and file separate estate and trust fiduciary returns for Pennsylvania.

Potentially higher income tax. Another potential disadvantage is that following the Settlor’s death, income from entrusted assets can potentially be subject to different (less favorable) tax treatment:

Unlike estates, trusts are required to file tax returns on a calendar year basis. That can sometimes complicate tax planning strategies (e.g. pushing income out to beneficiaries who are in lower tax brackets).

Although an election can be made at the federal tax level (IRC §645) to report the trust’s income and expense on the estate fiduciary return, in Pennsylvania, there is no such election at the state level.

If a significant portion of the decedent’s financial assets are titled in the trust, it can effectively separate taxable income (at the trust level) from tax deductions related to the estate administration (normally deducted on the estate’s fiduciary income tax return) which could otherwise be used to offset that income for tax purposes.

An election can be made at the federal tax level (IRC §645) to report the trust’s income and expenses on the estate fiduciary return.

However, the election requires the consent of both the estate executor and the trustee of the trust. If those parties are not one and the same person and they do not get along well, it may not always be possible to make the election.

Failure to update titling of accounts. If a settlor wishes to update his/her trust agreement, it is critical that any updated estate plan documents be properly matched up with any accounts or other assets that have been titled in the name of the trust.

So, for example, if the settlor creates a new revocable trust agreement, then he/she needs to either (i) caption the trust as the “trust agreement dated [date created], as amended and restated as of [date of amendment]” OR (ii) make sure that each and every trust account/ asset reflects the date of the new trust agreement.

If any trust assets do not match up with the revised trust document, the disposition of the asset would not be governed by that revised trust agreement. If the prior trust agreement is revoked or destroyed (as it almost always is when a new document is drafted), then there would be no trust document governing the disposition of those incorrectly titled assets.

Query: What if a client (settlor) decides he/she wants to get rid of an existing revocable trust and pass his/her assets under a Will? In that instance, it would be necessary to re-title all of the entrusted assets out of the name of the trust and back into the name of the client.

Jointly Owned Assets (with Survivorship Rights)

Forms of Common Ownership

Tenancy-in-Common. In a tenancy-in-common, each “tenant” (i.e. owner) owns a fractional interest in the subject property that can be passed on at death through that person’s Will or by intestacy. The deceased owner’s interest does not automatically pass at death to the other surviving owner(s). This is a type of common ownership that would be common amongst unrelated persons. For the most part, when we talk about “joint ownership”, we are not talking about this particular form of ownership.

Example: A and B own Blackacre as tenants-in-common. Each owns a one-half (1/2) interest in the property. A dies. A’s fractional one-half (1/2) interest in Blackacre will pass to whomever A designates in his Will, or if A dies intestate, then to A’s heirs under the intestacy laws.

Joint Tenancy with Rights of Survivorship (“JTWROS”). If an asset is owned by individuals as “joint tenants with rights of survivorship” (JTWROS), and one of the joint tenants (owners) dies, then the deceased owner’s interest in the jointly owned asset passes automatically “by operation of law” to the surviving owners.

Example: A and B are mother and daughter. A and B each own a one-half (1/2) interest as JTWROS in a certificate of deposit (CD) that is worth $50,000. A dies first. At A’s death, A’s one-half (1/2) interest in the CD passes automatically to B as the surviving joint tenant. So, following A’s death, B owns the entire $50,000 CD outright and free of trust.

Tenancy-by-the-Entireties. Tenancy-by-the-Entireties (T/E) is a form of joint ownership unique to married couples. Each of the spousal joint owners owns an undivided interest in the asset. There are some asset protection aspects that are specific and unique to the T/E form of ownership. However, in terms of how the assets pass at death, T/E works essentially the same as JTWROS: If one of the entireties’ owners dies, the deceased spouse’s interest in the property held as T/E passes automatically to the surviving spouse/owner.

Example: A and B are husband and wife. They own Whiteacre as T/E. A dies first. A’s interest in Whiteacre passes automatically at A’s death to B, so that B then owns 100% of Whiteacre.

Type of Assets Commonly Owned Jointly

1. Real Estate
2. Bank Accounts
3. Investment Accounts

Situations Where Joint Ownership Might Be Useful

Husband and Wife. One fairly obvious situation in which assets are commonly jointly owned is when they are owned by married individuals. In many (though certainly not all) cases, that may make sense, particularly if the assets are such that there are likely not any major income tax issues related to those assets – for example, a personal residence and a series of bank accounts owned by a married couple.

Sole Beneficiary. Another instance where joint ownership may make sense is where an individual has only a single intended beneficiary. So, if for example, an elderly parent is widowed and has only one child, whom he/she wants to designate as a joint owner on that account, it may make sense for that person.

“Convenience” Accounts. Another circumstance in which joint ownership of a particular asset (e.g. a bank account) may make sense is when the original account holder has difficulty getting around and therefore needs someone else to assist them in accessing the account. Sometimes a parent will, for example, name a child on an account as a “convenience” to the parent. The child may be more easily able to get to the bank and withdraw the money for the parent, or the child may be better able to manage money and may therefore assist the parent in that way.

Avoiding Will Contest. It is probably more difficult to challenge the validity of an individual’s decision to jointly title a particular account than it is to challenge a particular disposition in the individual’s Will. So a parent might conceivably decide to add a child’s name to an account with the thought that it might be less subject to challenge than a disposition of that account under his/her Will.

Reducing Inheritance Tax. If an account is made joint more than a full year prior to the decedent’s death, then only one-half (1/2) of the value of that account is subject to Pennsylvania Inheritance Tax. So if the individual has already decided that he/she wants that account to go to his/her child, it could in a particular case make sense to jointly title that account in the names of the individual and his/her child.

Potential Problems with Joint Ownership

Misuse of Funds (by other account owner). First and foremost, before putting someone else’s name on an account, a person should be certain that the other person (the person whose name will be added) would not use their status (as joint owner) to take advantage of the original account owner.

Example: Person “A” adds the name of another person (“B”) to his checking account, so that the account then reads “A or B.” Unbeknownst to A, B withdraws all the money from the account.

Divorce. Almost by definition, married clients rarely foresee the possibility of a future divorce. For that reason, it is particularly important to be aware of the full picture in advising clients in regard to the titling of their assets. For example, it is important to understand that by jointly titling an asset, an individual can cause an asset that would otherwise be treated as “separate property” (not subject to marital division) in the event of divorce to instead be viewed as part of the “marital estate” (subject to equitable division) in the event of divorce.

Example: “A” and “B” are married. A inherits $500,000 from his father. The $500,000 is viewed as “separate property” (not part of the marital estate) and therefore not subject to division in the event that A and B later get divorced. A then takes the $500,000 and puts it into a jointly titled investment account that is in both A’s and B’s names. By moving the money into a joint account, A has caused the $500,000 to become “marital property” subject to division in the event they (A and B) later get divorced.

Transferability. If an individual wants to be able to sell or transfer an asset at a later time (during his/her lifetime), then adding another person’s name to that asset could potentially frustrate (or at least complicate) that individual’s desire to be able to sell the asset.

Example: “A” owns his home. A wants to add the name of his son, B, to the deed. A later wants to sell the home. A needs B to also sign off on any transfer of the home.

Tax Ramifications (caused by out-of-order deaths). Joint ownership can sometimes cause unintended tax consequences when the joint owners do not die in the normal sequence.

Example: “A” and “B” are father and son. A is the father and B is the son. A adds B’s name to his bank account, so that the account now reads “A or B”. A’s intent is to pass the account on to B when he (i.e. A) dies. However, B predeceases A. Following B’s death, A owns 100% of the account, BUT A must pay inheritance tax on the value of one-half (1/2) (i.e. “B’s” half) of the account. So A in effect ends up paying inheritance tax on money that was really his all along.

Unintended Disinheritance. An important risk associated with jointly owned accounts is the potential inadvertent disinheritance of individuals whose names are not listed on the account.

Example: “A” has three (3) children, “B”, “C” and “D.” A puts B’s name on the account, so that the account now reads “A or B” (so that they are effective JTWROS with respect to that account). A added B’s name to the account merely as a convenience to A, because A is elderly and has trouble getting around. However, A’s intent was that when he dies, the account would pass equally to B, C and D. A then dies. At A’s death, the jointly titled account passes by operation of law to B. C and D are inadvertently “dis-inherited.”

Override of Estate Planning. Clients and/or advisors sometimes lose sight of the impact of asset titling (such as joint ownership) on estate planning. Often, an individual’s Will is the lynchpin in their estate plan. Consequently, by jointly titling a particular asset, that asset is effectively removed from the operation of the owner’s Will, because, by definition, assets that are jointly titled with survivorship rights pass automatically to the surviving owner.

Example #1: “A” is a widow with three (3) children: “B,” “C” and “D.” B is a mature young adult, C is a minor and D is a child with special disabilities who currently qualifies for Medicaid and SSI. A’s Will states that A’s estate is to be split in three (3) equal shares with one-third (1/3) passing outright to B, one-third (1/3) passing into a minority trust to be maintained for C’s benefit until C reaches age 25, and one-third (1/3) passing into a special needs trust for the benefit of C in perpetuity. A’s largest asset is a savings account with a balance of $1 Million. For the sake of convenience, A adds B’s name to the account, so that it reads “A or B.” A then dies. The entire account balance passes outright to B as the surviving joint account holder.

Example #2: “A” and “B” are husband and wife. It is the second marriage for each of them. A has two (2) children, “C” and “D,” from his previous marriage. B has three (3) children, “E”, “F” and “G,” from her previous marriage. A’s Will contains QTIP trust provisions, which in effect specify that any assets passing under the Will shall pass into a trust that will pay out all of the trust’s income to B during her lifetime (if she outlives A), and then when B dies, the trust assets will pass to A’s children, C and D. A’s biggest asset is an investment account worth $2 Million, which A re-titles into both of their names, so that it now reads “A or B” as JTWROS. A dies. Instead of passing under A’s Will into the QTIP trust, the account passes automatically at A’s death to B as the surviving account owner.

Assets Payable / Transferable on Death (POD/TOD Accounts)

Types of Accounts (that are transferred on death):

• “Payable on Death” (POD) Accounts (bank accounts)
• “Transferrable on Death” (TOD) Accounts (brokerage accounts)

Situations in which POD/TOD accounts may be useful or appropriate:

• If there is only a single beneficiary. If the decedent has only one intended beneficiary, and if that beneficiary’s name is the name listed on the account with the decedent (e.g., the account is titled “Decedent, payable on death to Beneficiary”), then the assets in the POD/TOD account are presumably going to go to the same person who would have gotten the assets under the Will.
• If the account balance is a small part of the decedent’s overall estate plan. If the POD/TOD account balance is only a small part of the decedent’s overall assets, then it is much less likely to have a major impact on the estate plan.

Potential Problems (What could go wrong?)

• Inadvertent Disinheritance (of intended beneficiaries). One of the concerns with a POD/TOD account is whether the beneficiary designation(s) covers all of the intended beneficiaries. One way that can occur is if intended beneficiaries die out-of-order. Another way it can occur is if the designated beneficiaries are not updated.

Example #1: Decedent (“D”) has three (3) children, “A,” “B” and “C.” D’s intent is to pass his estate equally to his three children if they are all still living at the time of his death, and to pass on any predeceased child’s share to that child’s children. A has three (3) children, “E,” “F” and “G.” D puts all of his liquid assets into an account titled “D, payable on death to A, B and C.” A dies first. Then D dies. D’s account passes to D’s surviving children, B and C. A’s children (D’s grandchildren) are left out in the cold.

Example #2: At a time when he is still single, “H” transfers assets to a TOD account. The TOD account is in H’s name, and the designated beneficiaries are H’s siblings (“I,” “J” and “K”). Later, H gets married to “W,” and has three (3) children,” A,” “B” and “C.” H never updates the titling of the account prior to the time of his death. On H’s death, the account passes to H’s siblings, I, J and K.

Undermining the Estate Plan. Another concern with POD/TOD accounts is that they have the potential to disrupt a decedent’s estate plan. That can happen because POD/TOD assets pass directly to the named beneficiaries without ever becoming part of the decedent’s probate estate. In most instances, the decedent’s Will is the linchpin (or at the very least an important part of) the decedent’s overall estate plan. However, the Will only governs those assets that pass through the decedent’s estate. So, by removing such assets from the estate, POD/TOD titling effectively “writes the Will provisions out of existence” as to those assets.

Example #1: “H” and “W” are married, and they each have large estates, each worth over $10 Million. Their assets consist primarily of investment securities. H and W have three (3) children, “A,” “B” and “C.” In order to take advantage of their federal estate tax exemption amounts ($5.45 Million each), H and W have Wills with testamentary trust (“bypass trust”) provisions. However, acting on the advice of their advisor, H titles all of his assets “H, TOD to W.” At H’s death, the assets transfer over to W, and the bypass trust created in H’s Will goes unfunded.

Example #2: “W,” a widow, has three (3) children, “A,” “B” and “C.” A suffers from a permanent disability that enables her to qualify for various forms of public assistance, including Medicaid, SSI, etc. B has a gambling addiction. C is under 18 years of age and is therefore still a minor. W’s Will creates different types of trusts for each of her children, A, B and C. However, in an effort to avoid probate, W is counseled to move all of her investment assets into a TOD account titled “W, TOD to A, B and C”. W transfers all of her assets to the TOD account and then dies. None of the transferred assets pass into trusts because they never passed under W’s Will. Instead, A, B and C each receive their respective shares of the assets outright and free of trust.

Misallocation of Inheritance Tax Obligation. One of the more subtle problems that can arise in connection with POD/TOD accounts concerns the apportionment of Inheritance Tax. It is not at all common to provide in the tax clause of a Will that all Inheritance Tax is payable “out of the residue” of the Testator’s (decedent’s) estate. If the residue of the decedent’s estate is distributable to one group of persons, and assets are moved into a POD/TOD account that is payable at death to another person (or persons), then the residuary beneficiaries are in effect obligated to pay tax on funds payable to other persons. If the funds in the POD/TOD account represent a sizable portion of the decedent’s estate it can be a significant problem, particularly if the decedent’s probate assets are minimal.

Example #1: “W” is a widow with no children. She has a brother, “B,” who has one child, “N.” Many years ago, W created a TOD account in her own name that was payable at her death to her nephew, N. W moved $200,000 into that TOD account. W also has another $100,000 solely in her own name. In her Will, W provided that the residue is distributable to her brother, B. W’s Will also states that any inheritance tax is to be paid out of the residue of the estate. W dies. The $200,000 in the TOD account goes to her nephew, N. The inheritance tax on that money comes to $30,000 (15% x $200,000), and it is paid out of the residue. So the “net” residue passing to her brother, B, will be only $70,000 ($100,000 minus the $30,000 inheritance tax).

Example #2: “W” is a widow. She has four (4) children, “A,” “B,” “C” and “D.” A is significantly older than the other three (3) children. Some years ago, before B, C and D were born, W created a TOD account in her own name that was payable at her death to her only child living at that time (A). W has $50,000 in the TOD account and $150,000 in another account solely in W’s name. W intends to provide equally for each of the children, and so her Will states that W’s $150,000 estate is to be divided equally among the other three (3) children, B, C, and D. W’s Will further provides that any inheritance tax is to be paid out of W’s residuary estate. W then dies. A gets $50,000, free and clear of any inheritance tax obligation. The inheritance tax obligation comes to $9,000 (4.5% x $200,000). The inheritance tax is paid out of the estate residue, leaving only $141,000 ($150,000 minus $9,000) to be divided among the residuary beneficiaries B, C and D. B, C and D each get $47,000 (after tax). W’s intention to provide equally for her children is not achieved.

Authors: Jeffrey D. Scibetta and Boutros Imad

Originally published in October 2023

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