You can arrange your individual retirement account (IRA) in such a way so that when you die, the account passes directly to your beneficiary. The same is true for a life insurance policy, a 401(k) account, or a payable-on-death bank account (sometimes called a POD account or Totten trust). Assuming you have filled out the proper paperwork, the asset will go straight to your beneficiary, bypassing probate and its potential costs and delays.
What about a brokerage account that holds shares of a mutual fund, stock, or other investment security? These typically must pass through probate. Beneficiaries must wait.
There is a seldom-publicized tool you can use to ensure that non- retirement investment accounts also pass directly to beneficiaries upon your death. It is called transfer-on-death registration or TOD registration, for short.
Following is a summary of TOD registration, how it works, and how it may play a role in your estate plan.
Transfer of Assets
When someone dies, the person leaves behind assets intended for heirs or other beneficiaries. When this happens, “There’s got to be some orderly process to move assets from an individual to other individuals or an institution,” said Edward M. Mazze, a former dean of the Belk College of Business at the University of North Carolina at Charlotte.
The process can be straightforward. Suppose that Mason and Olivia are married, all of their assets are in accounts registered as joint tenants with right of survivorship, and Mason dies. In that case, the assets generally will pass to Olivia, outside of probate.
But what if the decedent is not married at the time of death? Depending on the nature of the assets and other factors, it may take time until that person’s assets pass into the hands of beneficiaries, said Karen Denise, senior manager in the CAPTRUST Wealth Operations Group in Raleigh, NC. In some cases, it could take several months or longer, especially if the assets must first go through probate, Denise said.
What is Probate?
Probate is the court-supervised, legal process triggered when someone dies. Probate has its advantages. For example, through probate, the validity of the decedent’s will is determined; property and other assets are marshaled, inventoried, and valued; and disputes among creditors and will contestants can be heard and resolved. If there is no will, assets generally pass according to terms of state law as part of the probate process.
In some states and for small estates, beneficiaries can expedite the probate process. Too often, however, probate can take a while. “You can’t just take your assets on Monday and give them to someone on Tuesday,” said Mazze, Distinguished University Professor of Business Administration at the University of Rhode Island.
Probate “can be cumbersome, costly, and time-consuming,” said Danny Summerlin, CFA, a senior vice president and financial advisor with CAPTRUST.
With TOD registration, the account goes directly, without any restrictions, to the named beneficiary, sidestepping probate.
Assets can also pass directly to beneficiaries by means of certain trusts. However, trusts can be complex and costly to establish and administer, Denise said. TOD registrations, on the other hand, are easy to set up and administer. More importantly, they enable heirs to receive their shares quickly.
If you name a beneficiary through a TOD registration, the assets in your account remain in your name and control. The account does not pass to the beneficiary or beneficiaries until your death. No beneficiary has ownership or other rights to the account while you are alive.
During your lifetime, you also have the right to change your beneficiary designation or revoke it at any time without the beneficiary’s knowledge or consent. “You can change the beneficiary designation with great ease,” Summerlin said. In addition, he said, “there is no cost to change the beneficiary designation as there would be in modifying a legal document, such as a will or a trust,” he said.
You can name more than one beneficiary for each account. The beneficiary need not be a relative. It could be a friend or neighbor — or even a charity or trust. It’s up to you to choose.
How it Works: Owner
Although TOD registration is well known among financial institutions, it is not among consumers, Denise said. “It’s not something people think of when they think of brokerage assets,” she said. Even so, it is widely available, and “it’s free ... there’s no cost to do it,” she said.
To take advantage, ask your financial institution for a copy of its TOD form. If you work with a financial planner or other advisor, that person may be able to assist you.
Complete and file the form as directed by your financial institution. TOD registration applies to the account, whether it is an individual account or a joint account with rights of survivorship, Denise said. Once the form is processed, registration of your account may be shown by the following:
• the words “transfer on death,”
• the abbreviation “TOD,”
• the words “pay on death”, or following the name of the registered owner
• the abbreviation “POD” (and before the name of a beneficiary).
For example, if John S. Brown has a TOD account for his son as beneficiary, the account’s title may read: “John S. Brown TOD John S. Brown, Jr.”
How it Works: Beneficiary
Under TOD registration, your designated beneficiary steps into your shoes as the account owner upon your death, Denise said.
The beneficiary can either request a cash distribution of the assets or open a new account in his or her name and have the assets in the deceased’s account transferred in, Summerlin said.
To claim the owner’s account after death, the beneficiary or beneficiaries must provide a certified copy of a death certificate and other paperwork the financial institution requires, such as an application for liquidation, forms for re-registration in the beneficiary’s name, and a tax waiver (depending on state rules).
Although registering an investment account through the TOD procedure is usually a simple and straightforward affair, there are some issues to keep in mind.
For example, while TOD registration is widespread, it is not universal. It is made possible through the TOD Security Registration Act, developed in 1989 by the National Conference of Commissioners on Uniform State Laws, also known as the Uniform Law Commission. Since then, most states have adopted the uniform TOD law. Texas and Louisiana have not, said Katie Robinson, deputy legislative director and communications officer for the Uniform Law Commission.
Also, the law does not obligate financial institutions to offer the TOD feature; it is up to the brokerage, bank, mutual fund, or other custodian of non-retirement investment securities. Most offer the TOD option; some do not.
While the TOD beneficiary designation form itself is fairly standard throughout the industry, there are variations, much as there are with beneficiary forms for IRAs and 401(k) plans. So it pays to scrutinize your financial institution’s TOD form to make sure it meets your needs. And remember that if you live in a community property state, special rules apply.
One of the TOD option’s chief advantages—its simplicity—can also be one of its disadvantages, depending on one’s circumstances. If you have a complicated estate plan or would like to use your assets in a particular way after your death, the TOD option may not be best for you.
Suppose that Sandra wants her investment assets to be used exclusively to pay for the education expenses of her surviving nieces and nephews—and only when they have achieved a certain goal (college graduation, for example). In that case, the TOD option would not work well; Sandra’s investment account would pass directly to her nieces and nephews upon her death with no strings attached.
Similarly, someone with children from different marriages, or a child with special needs, may be better off leaving assets in trust, with carefully laid plans for supervision and distribution.
Furthermore, “You do not want to name minor children as your beneficiaries” because such a move could be complicated by issues involving guardianship, Summerlin said. A TOD registration is “not the best solution for minors, but a very good solution for adult loved ones,” he said.
Death and Taxes
Another point to remember is estate expenses and liquidity. For example, will there be enough assets to cover estate taxes?
The TOD account’s underlying assets will be counted for purposes of any federal estate tax and state death tax that may apply. In general, the point at which the federal estate tax kicks in — known as the threshold, or exemption amount — is set at $5.43 million for 2015, so many estates will not be affected by the tax. Still, several states have their own estate taxes, some with thresholds far below the federal one.
The lesson: in the event you decide to use TOD registration, you should also plan to set aside enough cash to pay any tax that may be due, as well as funeral and other such expenses.
TOD registration is not a substitute for careful and effective estate planning, which is especially important for people with larger estates and complex financial and family situations.
Broadly speaking, estate planning means “getting everything in order” in advance, Mazze said. It may include establishing a will; drafting instructions for your care should you become incapacitated before you die; arranging for a guardianship for minor children; and planning for those with special needs, for example. Estate planning is also important “because it gives an individual as well as a family … an idea of what property exists and where that property is located,” Mazze said.
As part of the estate planning process, perform a checkup at least annually or when there is a major life event, such as a death in the family or a divorce, to make sure that the beneficiary form is current and that the account with a TOD registration still fits with your plan, Denise said. “If they’re not correct, your wishes at death may not be fulfilled,” she said.
As Summerlin noted, “Regardless of what the last will and testament stipulates, beneficiaries named in the TOD trump what the will says.” So make sure in advance that the two do not conflict.
Because one’s estate may be complicated, and because the process of estate planning can itself be complex, “you should get professional help” before making decisions, Mazze said.
About the Author
Neil Downing is a Certified Financial Planner™ and enrolled agent, licensed by the U.S. Treasury to represent taxpayers before the Internal Revenue Service. A newspaper reporter, editor, and columnist for 35 years, Downing has authored several publications focused on maximizing the value of employee benefits and retirement savings vehicles.