Beware Direct Transfer Designations (TODs and PODs)

If you are planning to Age in Place, you should not rely upon direct transfer designations, like POD's (payable on death designations) and TOD's (transfer on death designations), or simple beneficiary designations as a primary component of your estate plan.  These designations are mechanisms by which an account or other asset is transferred or paid on the death of the owner to a beneficiary. They are often recommended by the administrator of the account, such as a bank, broker or life insurance company. While these can be very effective and inexpensive means by which to avoid probate and transfer assets at death, they are not without their risks and challenges. A lack of careful consideration of the risks and rewards of these mechanisms can be disastrous. A carefully prepared estate plan will consider, and resolve, all of the risks and challenges they present.

Benefits of Direct Transfer Designations

Direct transfer designations have several benefits. The most important benefit is that they are inexpensive and relatively easy to employ. Most institutions will permit you to make such designations as a service, for no additional fee. They are simple to create, and there is no need for an attorney or other professional. Most of these designations are made by account owners without legal or professional advice or counsel. Particularly because of this simplicity, they are very popular.

The second benefit is that the payment or transfer is more or less immediate and direct. Where there is a need to make cash or other liquid assets immediately available to a child or grandchild for some purpose, a TOD or POD appears attractive at first glance. Beneficiary transfers, however, typically require claim forms, and documentation in support of the claim. In reality, the process may take more time and effort than succession of ownership (such as through a living trust or joint tenancy with right of survivorship). Nonetheless, it is the assumption that funds are available immediately that often causes folks to choose direct transfer designations.

Unquestionably, direct transfers can have unique benefits as a result of direct payment to a beneficiary, whether or not immediate. For example, if you are widowed and want the bulk of your estate to pass to your children, but still desire a particular asset, fund, account or benefit to pass to a significant other or second spouse, without involvement of your children, a direct transfer seems suited for this purpose. Of course, such circumstances are specific, unique, and situational. The proper method for accomplishing an intended result depends upon first carefully considering all options to ensure that the proper tool is selected.

The third benefit is that a direct transfer designation may avoid probate, provided, however, that the beneficiary is alive at the death of the account holder or owner, and there is no intervening circumstance that interrupts direct payment to the living beneficiary; a beneficiary's disability, need for government benefits eligibility, creditors, marital disputes, and the like, may frustrate an effort to protect assets from legal or court administration. 

If the beneficiary passes before or after, the asset may be probated. Particularly because the avoidance of probate may not be effective, TOD's and POD's are of limited utility in a carefully planned estate. Not surprisingly, because they are available at little or no cost, they are often used for the sole purpose of avoiding probate - an inexpensive substitute for more comprehensive planning. Make no mistake--these devices are NOT substitutes for comprehensive plans or living trusts. If you have utilized TOD's or POD's in your estate plan, particularly if you have done so without professional guidance, you may want to consider carefully the many possible disadvantages of these tools, and consider a more appropriate planning technique.

These designations simply do not, at least effectively, accomplish goals best achieved by proper estate planning. For example, these devices do not avoid estate taxes, reduce the risk of guardianship, protect assets from control by a court-appointed guardian, or permit in and of themselves management of assets during periods of incompetency or incapacity. They may not even avoid probate of the asset.

Additionally, there are several potential drawbacks to such devices, particularly if they are used without careful consideration or the advice of counsel. The biggest drawback to these plans is that they do not and cannot plan for contingencies. Additionally, use of such designations can cause illiquid estates, lead to or cause unintended disinheritance, lead to lawsuits or disputes, and can facilitate or encourage guardianship.

Proceeds from Direct Transfer Designations Do Not Have to be Used as Intended

Among the most common mistakes is to leave an account to a particular person, usually the person you intend to be the executor of the estate, for a specific purpose such as paying your funeral bill, or satisfying a mortgage. Unfortunately, the beneficiary is not required to use the funds for your intended purpose.  This can result in one of your children receiving a windfall, by pocketing the account, and having the obligation to be paid from other estate assets. 

Consider the following example:

Mrs. Smith leaves a twenty thousand dollar ($20,000.00) CD payable upon death to her daughter Patty, her executor, so that Patty will have immediate funds available to pay the funeral bill.  Mrs. Smith directs her home and her bank and savings accounts, worth a combined one hundred and fifty thousand dollars ($150,000.00) to her three daughters by way of a Last Will and Testament. 

Although she intended each daughter to receive an equal amount, or fifty thousand dollars ($50,0000.00), this is not the result. Patty keeps the twenty thousand dollars ($20,000.00) as her own.  Patty acts as executor of the estate, and pays the ten thousand ($10,000.00) funeral bill as an expense of the estate. Patty pays six thousand five hundred dollars ($6,500.00) in medical and other bills, and expenses from the estate.  Patty is paid six thousand dollars ($6000.00) as the executor, and an attorney is paid seven thousand five hundred dollars ($7500.00) in attorneys fees, costs and expenses. The resulting net estate is one hundred thirty thousand dollars ($130,000.00), resulting in each daughter receiving an equal approximately forty-three thousand dollars ($43,333.33).  Patty received total distributions from her mother in the amount of sixty three thousand dollars ($63,333.33), twenty thousand more than her sisters. Additionally, Patty also received an executor's fee for the work that she performed in settling the estate.  

Direct Transfer Designations Do Not Avoid Estate Tax

If you have any incident of ownership in or to an account or other asset, it will be included in your taxable estate for estate tax purposes. Consequently, direct transfer designations are not appropriate tools for estate tax planning.  If you intend to remove the value of the asset from your taxable estate, you must do more. Generally, unless some other reason for excluding the account exists, the account will be included in your taxable estate notwithstanding the direct transfer designation.

POD's and TOD's May Not Avoid Probate

There are numerous instances where these techniques have been used to avoid probate, and yet the assets of the estate are nonetheless probated. Transfer upon death designations are not typically made for personal property, and may in fact be unavailable to transfer such assets. If there are sufficient assets to probate, the other assets will pass through probate, even if liquid or other property avoids probate.

Moreover, these designations do nothing to protect assets from administration by a guardian or conservator in the event of incompetence or incapacity. They also do not prevent challenges to a will, appointment of executor, or other legal disputes which may ultimately be resolved by the probate court.

Finally, these designations will not avoid probate if the beneficiary passes away either before or after the account or asset owner. A probate administration may be necessitated, whereas property passing by way of trust will not need to be probated in the event of the death of an heir, whether that death occurs before or after death of the owner.

Direct Transfer Designations Do Not Aid In Aging in Place

Aging in Place is the desire of almost every senior.  For some, it is only a  hope, desire, or aspiration.  For others, it is a fundamental objective forming the basis of a comprehensive estate and financial plan. Direct Transfer Designations do nothing to aid in a plan designed to enable you to Age in Place.  Simply, because these designations only "work" after you have passed, they are incapable of aiding in your efforts to Age in Place.  

Moreover, to the extent that the use of such designations abandons more comprehensive plans that, for example, change traditional fiduciary duties to permit use of assets for more expensive alternatives to institutional care, they indirectly frustrate your Aging in Place plans.  For more information regarding Aging in Place, go here.    

Direct Transfer Designations Do Not Avoid Guardianship

Direct transfer designations do nothing to protect assets from administration by a guardian or conservator in the event of incompetence or incapacity. Failing to protect yourself and your estate from guardianship impairs any plan to Age in Place.  For more information regarding the danger of guardianship generally, consider the Open Letter to Congress, drafted by the National Association to Stop Guardian Abuse, or review Guardianship over the Elderly: Security Provided or Freedoms Denied?, Hearing Before the Special Committee on Aging, United States Senate.

 Direct Transfer Designations May Create Illiquid Probate Estates

One potential drawback to these designations, particularly when placed on all liquid checking, savings, and investment accounts is that an estate can be made illiquid. Lack of liquidity can be a problem where there is real estate, personal property, or other assets that must be probated. Probate administration and estate taxes must be paid, and if the probate estate is insufficient to do so, heirs may be required to return cash to the estate, or property may be sold at fire sale prices to satisfy obligations. It is important to consider that ad hoc asset level planning to avoid probate often leaves assets to be probated.

Direct Transfer Designations Do Not Plan For Contingencies

The biggest disadvantage is that these devises are usually limited, and do not provide for contingencies. These plans very rarely answer the "what if?" questions considered by a carefully prepared estate plan. For example, what if the transferee or payee dies shortly before or after the owner? In most cases, the designation will simply pay the estate of the deceased transferee or payee. If, for example, the payee is your son, and he dies before you, without a will, the account or asset will be paid in whole or part to your daughter-in-law. You may desire that no part of your estate pass to the spouses of your children, in order to protect your grandchildren in the event of remarriage. Moreover, if you intended to avoid probate of your assets, you may fail in your efforts.

There are numerous examples of contingencies that a living or even a testamentary trust can address which are not typically addressed by POD's and TOD's. What if the property passes intentionally or unintentionally to a minor? Do you want the property to be distributed to the minor upon his or her reaching age eighteen or obtaining emancipation, or would you prefer to protect minors from their inexperience and lack of wisdom in managing assets?  Did you anticipate that a guardian for the minor may need to be appointed in the probate court to oversee the assets, with the attendant burden, cost, and expense, even if you trust the minor's parents to manage the assets? 

What if the heir has financial difficulties, lawsuits, judgment liens, tax liens, or similar problems at the time of your death? If you do not intend your assets to pay the claims of third parties against your heirs, you should consider an alternative to a simple TOD or POD.

What if your heir is undergoing a divorce, dissolution, separation, or other marital difficulty? A TOD or POD may or may not be involved in such a dispute, depending upon a number of factors and your state law.

What if an heir is handicapped mentally or physically at the time of your death. If you want to protect that heir, you may want more than a simple TOD or POD.

What if an heir suffers from a substance abuse or other dependency that could affect their ability to manage their affairs? TOD and POD clauses rarely protect a family from such contingencies.

What if an heir joins or becomes a member of a religious organization, cult, or other organization pursuant to which your heir agrees to surrender or deliver all of the heir's assets? You may not want your worldly possessions to facilitate or benefit the organization or cult.

What if there is a dispute, contest, or lawsuit? How is the dispute to be resolved, and on what basis?

Regardless which "what if" question concerns you now, you should consider many possible contingencies. As a result, a carefully considered and well drafted estate plan will consider and provide solutions to all of these and many more. TOD's and POD's simply have no solutions, because they are not, in and of themselves, "plans."

Direct Transfer Designations Can Lead to Unintended Disinheritance

Another disadvantage of direct transfers is that they can lead to unintended disinheritance. This occurs because folks often use these to segregate accounts. In other words, a person will select one account with a TOD or POD designation for one heir, and another account for another heir. This is often done to keep confidential account balances which may favor one heir as against another. These can be disastrous in an estate plan. Consider the following example:

Mrs. Smith has three children and three CD's. Two CD's are worth ten thousand dollars ($10,000.00), but the third is worth twenty five thousand dollars ($25,000.00). Smith's oldest daughter lives very near, is often helpful in Smith's day-to-day activities, and is Smith's designated attorney-in-fact/agent. Smith makes the larger CD payable upon death (POD) to the oldest daughter, but makes the others payable to the other children. Unfortunately, Smith suffers a stroke and undergoes lengthy period of convalescence, including a stay in a nursing home. The expenses require the daughter, now acting through power of attorney, to liquidate one of the smaller CD's, and to liquidate the larger CD to cash, of which she spends ten thousand dollars ($10,000.00). Assuming the only asset remaining at Smith's death is the checking account, which is now worth only approximately fifteen thousand dollars ($15,000.00), and the remaining CD which is worth ten thousand dollars ($10,000.00), you can see how the POD failed to effectuate her wishes. The checking account is divided equally between the children (five thousand dollars ($5000.00) each. Widow Smith probably assumed like many people that the checking account would only have a nominal amount of money in the account, which may not be true as the family deals with medical or other crises. Instead of the oldest daughter receiving twenty five thousand dollars ($25,000.00), she receives only five thousand ($5000.00). One of the other children receives fifteen thousand dollars ($15,000.00). It is obvious the results were not in keeping with the intentions of Widow Smith.

An Attorney-in-Fact May Change Your Wishes

Most people who have utilized direct transfer designations assume that their estate plan is set, and their wishes will be followed. Sadly, nothing could be further from the truth. A direct transfer designation is typically a contractual right, which can be changed by an attorney-in-fact. Moreover, an asset can be transferred, and the designation "undone" by any person with authority over you or your estate, such as a guardian or conservator. Bottom line? A beneficiary designation is simply not an adequate estate plan for most people.

Direct Transfer Designations May Lead to Lawsuits Or Disputes

For all of the foregoing reasons, and countless others, direct transfer designations may cause your estate to be contested, and may encourage, rather than discourage lawsuits and litigation.  Particularly because these designations may create expectations in the minds of heirs, and because their use certainly does not discourage, and may encourage disputes, reliance on these in your estate plan might even encourage a guardianship application by an otherwise well-meaning heir as he or she seeks to protect their inheritance from others.

Guardianship proceedings may be necessitated by assets passing to contingent beneficiaries, as well, such as underage grandchildren. Since the goal of such designations is primarily probate avoidance, careful and limited use of such designations in an estate plan is warranted.

There is no substitute for a carefully considered and well drafted trust to ensure that your wishes are expressed and carried out.

[Note: This article is largely based upon another, earlier article written by Attorney Donohew, which article can be found here.]