Your client has prepared estate documents to ensure that his assets are passed to the next generation according to his wishes. However, his will and trusts are only one part of the framework that dictates how his assets will be distributed after his death. The other important components are account titling and beneficiary designations. Coordinating account titling and beneficiary designations is a critical, yet often overlooked, element of a successful estate plan. It can ensure that your client’s assets pass to his heirs in the way in which he intended and help minimize estate taxes.
Many people unwittingly title accounts or designate unnecessary beneficiaries in a way that undermines the estate plan established in their will and trusts. Help your client avoid these needless errors by explaining the various account titling options and the use of beneficiary designations.
Why Account Titling?
The way in which an account is titled is legally significant and can supersede your client’s estate plan. Here are the most common account titles and their legal impacts.
- Individual accounts. One person or entity owns this type of account. This choice is the most direct way to assure the wishes in your client’s will prevail. Assets that are titled in your client’s name will pass according to his estate plan as long as your client doesn’t have a different beneficiary designated. Assets from an individual account will be added to the total estate and will be subject to probate and taxed at the prevailing estate tax rate in the year of the owner’s demise. This choice is the simplest way to ensure that your client’s estate plans will prevail.
- Joint Tenants with right of survivorship (JTWROS). This is one of the most common ways married couples title accounts without giving it a second thought. This type of account will pass directly to the surviving account holder when the first account holder dies. However, review the following considerations with your client before he chooses this type of title.
JTWROS for non-taxable estates. JTWROS accounts are an easy choice for a simple estate that doesn’t require advanced planning nor exceeds prevailing estate tax thresholds. Assets can automatically and immediately pass to your client’s heirs if he’s a joint holder, and a responsible joint holder can take over your client’s affairs if your client becomes incapacitated or impaired.
JTWROS titling will supersede a will. A major problem with JTWROS is that the account won’t pass according to the decedent’s will and, therefore, it should rarely be used if your client has significant assets. The joint tenant who dies is presumed to own 100 percent of the property. As a result, the deceased tenant’s family loses the property as it passes to the surviving joint tenant and the family must pay any estate taxes if the joint tenant isn’t the spouse.
Using a child for safety and ease may be a completed gift. Adding a non-spouse to a JTWROS account often creates a gift tax. For example, if your client designates a son or daughter as a joint tenant on a bank account or other property, he makes an immediate gift of one-half the value of the property. Also, if your client has two children and names one as a joint tenant on a house or bank account for convenience, then that child inherits the property, no matter what your client’s will says. The child is legally entitled to the entire property, and if he chooses to share the property with siblings, he may have to pay a gift tax.
Adding a joint tenant passes on cost basis. If your client shares a piece of property as JTWROS or if your client adds someone else to the title of his property as JTWROS, that person also gets the tax basis of that property. When the surviving tenant sells the property, the estate loses its "step-up" in basis and is liable for the capital gains tax.
- Tenants in common. This title is the recommended choice for shared accounts that will be subject to a will. While all of the account holders are alive, the account is owned by the holders in proportion to the amount they contributed to the account. When one of the account holders dies, his interest will pass to whomever he has specified in his will or to his heirs as dictated by law if he doesn't have an estate plan. The assets are considered owned equally among the number of common tenants on the account or property. A tenants-in-common title ensures that assets are passed according to your client’s estate plan and is a good choice when there’s no need to use living trust structures.
- Convenience account. About half the states have adopted the Uniform Multiple-Person Accounts Act legislation for regulating what we often call “convenience accounts.” With these accounts, there may be multiple holders exclusively for the convenience of the account holder. It may be that your client wishes to have an adult child help to pay bills and reinvest the amounts in the account from time to time, but your client doesn’t intend for the child to inherit the entire account. The convenience account works like a power of attorney, except that the signer’s authority is limited to the particular account. There’s no right of survivorship; so the account will transfer according to your client’s will. The convenience account is a good choice when your client wants the security of another trusted person having access to his account.
- Payable on death (POD)/Transfer on death (TOD). Sometimes called a “designated beneficiary title,” this is a designation added to an individually titled account. In specifying a specific beneficiary, the assets will be automatically transferred to the designated beneficiaries on the account holder’s death without going through probate. This titling will supersede any instructions in a decedent’s will.
This may be a good choice to consider if your client has no heirs and wishes to simply identify beneficiaries. This designation allows your client to specify both multiple beneficiaries and the percentage of assets each will receive. If the POD beneficiary dies before the account holder, his share is eliminated and is divided among the surviving POD beneficiaries.
With the POD registration, your client maintains complete control of his assets during his lifetime. The named beneficiaries have no access to or control over the assets as long as your client is alive.
What’s a Beneficiary Designation?
Some important assets are transferred exclusively by a beneficiary form, irrespective of instructions in your client’s will. They’re referred to as “true beneficiary designation assets.” These assets include: life insurance, qualified employee benefit plans (such as 401k plans and 403b plans), individual retirement accounts and annuities. Having beneficiary designations on these accounts match the rest of your client’s estate plan is critical to having the plan work the way your client wants.
Some examples of accounts that aren’t true beneficiary designation assets are after-tax assets such as bank accounts, CDs held outside of an IRA and brokerage accounts that aren’t inside an IRA. Your client shouldn’t put a name of a beneficiary on these types of accounts. If he does, he’ll be removing these assets from his estate plan.
For beneficiary assets, there’s a specific form that your client should carefully complete identifying his beneficiaries and his desired percentage distribution to each beneficiary. Your client should also name contingent beneficiaries on these assets. A contingent beneficiary adds extra flexibility to estate plans. If a named beneficiary pre-deceases your client and there’s no contingent beneficiary, your client’s assets could be distributed through his estate with higher taxes consequence. A contingent beneficiary designation also adds flexibility to your client’s estate plans allowing a named beneficiary to disclaim a qualified inheritance asset such as an IRA, thereby passing it immediately to the contingent beneficiary.
Life changes, so keeping beneficiary forms up to date is equally important. Your client should maintain a file of copies of all his beneficiary designation forms. He should also consider setting up a reminder to himself to review these every five years and at any major life event such as a birth, death, marriage or divorce to ensure that they reflect your client’s current wishes.
It’s imperative that the three elements of the estate planning framework- wills, account titles and beneficiary designations- are implemented in a coordinated manner so that your client achieves the goals of his carefully considered estate plan. We recommend that your client request a copy of his original account agreements and beneficiary designations from every financial institution where he has accounts to ensure that the account titles and beneficiary designations are consistent with your client’s estate plan.