When used in consultation with an estate planning attorney, transfer-on-death (TOD) or payable-on-death (POD) designations on financial accounts can be valuable estate planning tools. However, these account designations have the potential to derail an estate plan when not coordinated properly with the overall plan. Consulting with an estate planning attorney is critical when considering a TOD/POD designation, and caution is required when opening financial accounts to avoid unwanted results.
Transfer-on-death (TOD) or payable-on-death (POD) designations can be placed on most financial accounts to name a beneficiary to receive the account assets upon the death of the account owner. A primary benefit of using TOD/POD designations is that assets held in the account will pass automatically to the beneficiary without having to go through probate. One or more beneficiaries can be designated to receive an account, and such designations are fully revocable by the account holder while he or she is living.
TOD/POD designations are typically simple and easy to implement. The account holder can designate a beneficiary or revoke any such designation by completing paperwork with the financial institution administering the account. In fact, many financial institutions ask account owners to name a beneficiary when a new account is opened.
But TOD/POD designations can derail an estate plan in numerous ways:
- TOD/POD designations remove assets from the probate estate. Estate planning documents can only operate on assets that pass through probate or are otherwise directed to a revocable trust. If family members or trusts are included in an estate plan but TOD/POD designations direct most of a decedent’s assets elsewhere, the provisions of the estate plan cannot override the TOD/POD designations and will not be implemented. However, when thoughtfully set up in consultation with an estate planning attorney, TOD/POD designations can be used effectively in conjunction with an estate plan to avoid probate while ensuring that the provisions of a revocable trust are still operative, such as by naming the trust as the beneficiary.
- TOD/POD designations affect tax-efficient planning and planning using trusts. When an estate plan includes sophisticated tax planning — such as the use of credit shelter trusts, marital trusts, and/or generation-skipping transfer (GST) trusts — directing that assets pass to beneficiaries through a TOD/POD designation could prevent the implementation of these tax planning strategies. For example, if an estate plan provides for the creation of a GST trust or a trust specifically designed to hold assets for a spouse but the decedent’s financial account has a TOD/POD designation in place naming the descendants or spouse directly, the assets will not pass to the intended trust(s) under the terms of the estate plan. In addition to directing assets in a way that contradicts an estate plan, such a mistake can result in unused tax exemption(s).
- TOD/POD designations can create liquidity problems in an estate. If all or substantially all of an individual’s financial accounts pass by TOD/POD designations, leaving only illiquid assets such as real estate or closely held business interests in the estate, there may not be sufficient cash held in the estate to pay funeral and administration expenses, final bills, legal fees, and any federal or state estate tax that might be due. In such a case, the personal representative would need to recover necessary funds from the beneficiaries of an account with TOD/POD designations.
- TOD/POD designations can undermine changes made to an estate plan. As circumstances change, people often wish to reconsider their estate planning goals; it is easy to forget to update TOD/POD designations at the same time, especially if one’s estate planning attorney is not aware of such designations. This inadvertent omission increases the risk that one’s wishes will not be carried out upon death.
If you are considering putting a TOD/POD designation on a major financial account or think there might already be a TOD/POD designation on any of your financial accounts, please consult with your estate planning attorney to discuss how that designation should be integrated with your estate plan.
Mary-Kathleen O'ConnellPartnerCo-Chair, Trusts & Estate Planning
Susan L. AbbottPartnerChair, Tax Exempt Organizations, Co-Chair, Trusts & Estate Planning
Lisa A.H. McChesneyPartner