APRIL 23, 2012 VOLUME 19 NUMBER 16
Let us try to demystify probate avoidance for a moment. Note that for the purposes of this description, we are not going to argue with you about whether avoidance of probate is good, bad, desirable or a foolish goal — we start here with the assumption that probate avoidance is important. Another day, perhaps, we will discuss with you whether you ought to be concerned about probate avoidance.
Definition of terms first: probate is the court process by which your estate is settled and distributed to your heirs (if you have not made a valid will) or your devisees (if you have). Confusingly, “probate” is also the term applied (in most states) to the court where probate proceedings, guardianship, conservatorship and sometimes even civil commitment and adult adoptions are conducted. We are not talking here about how to avoid probate court altogether, but just about how to keep your estate from having to go through the probate process upon your death.
Arranged (more or less) from least desirable to most, here are some of the ways to avoid probate of your estate upon your death:
Die poor. In Arizona, an estate consisting of up to $50,000 of personal property can be collected by the people who claim to be entitled to it without the need of a probate court proceeding. The affidavit for collection of personal property is widely available and usually free. Your survivors can use it to transfer title to your auto, or to collect small bank (or other financial) accounts. The statute providing for collection of small estates also provides a mechanism for the surviving spouse to get a decedent’s last paycheck, and for beneficiaries to transfer title to real property up to another $75,000 in value. Most other states have a similar law, but with dollar limits that vary widely.
Give it all away. One sure-fire way to avoid probate: give everything to your kids (or whomever you want to receive your stuff) now. The main problem with this approach should be obvious — what if they won’t let you live in your house any more, or withhold the interest you counted on them returning to you each month? Things change: you might change your mind about leaving everything to that child, or to all your children. The child you transfer assets to might marry someone you don’t trust. Worse yet, that child might die — leaving you at the mercy of his or her spouse and children. Maybe you and the child you give your stuff to will end up disagreeing about when you need to go to a nursing home, or whether you ought to get married late in life, or even take in a roommate.
As an aside, it amazes us how often clients come to us after having given everything to their children. Things so often do not work out as planned. This is a very poor way to handle your estate planning — but it would avoid probate. We hear that those new-fangled strap-on jet packs avoid traffic jams, too — but we don’t recommend them as a means of getting to the doctors office.
Joint tenancy. People often refer to this method of holding title by its formal name: “joint tenancy with right of survivorship.” That makes the value of the title pretty clear — the surviving joint tenant(s) own the deceased joint tenant’s portion of the property upon death of one joint tenant. You can have more than two joint tenants — upon the death of any one, the survivors’ interests all increase. We liken this arrangement to a tontine — a lovely idea that combines the best elements of estate planning and lotteries.
Lawyers generally discourage the use of joint tenancy in estate planning. The problems are less obvious than simply giving away your stuff, but they are still real. You might later decide that the child you established the joint tenancy with should get a larger or smaller share of your estate — but the joint tenancy is always, by definition, an equal ownership interest with all the other joint tenants. People who favor joint tenancy as an alternative to good estate planning invariably, in our experience, seem to think it would be OK to name just one child as joint tenant, and to trust her (or him) to divide the property among siblings. That often works just fine — but it often leads to family disputes when the children have different expectations or understandings.
Other problems with joint tenancy: you subject your property to the creditors, spouses and business partners of the child you put on your title. You lose the power to refinance your home, to cash out your certificate of deposit, or to liquidate your government bonds — more accurately, you lose the power to do those things unless your joint tenant will also go to the title company or the bank with you and sign willingly.
Lawyers tend to dislike joint tenancy, except in one circumstance. Many people own their property in joint tenancy with spouses (homes are especially likely to be titled in that fashion), and we lawyers generally think that is alright. In Arizona, there is another alternative between spouses that we like a little better: community property with right of survivorship. That conveys some income tax benefits to a surviving spouse while still avoiding the necessity of any probate on the first spouse’s death.
Beneficiary designations. You probably have a beneficiary (maybe multiple beneficiaries) named on your life insurance policy, on any annuities you have been talked into buying, and on your retirement account (if there is any death benefit included). Did you know that you can do the same thing with bank accounts, stocks and bonds, and even (in Arizona and a handful of other states) real estate?
- POD (payable on death) bank accounts — you can designate a POD beneficiary (some banks use the acronym ITF — “in trust for” — and it means the exact same thing) who has no current interest in your account but receives it automatically upon your death. You can even name multiple POD beneficiaries. And you can do this at banks, credit unions, savings and loans. Caution: if you go to your bank and say “I heard that there’s a way I can put my son’s name on my bank account” the clerk will almost always hand you a joint tenancy signature card. Make clear that you’re talking about POD designations — they are used less commonly but are a better fit for most people.
- TOD (transfer on death) for stocks and bonds — there is a designation similar to the bank POD account for stocks, bonds, brokerage accounts and mutual funds. It is usually referred to by its acronym, TOD. It is actually more flexible than the POD designation available to banks — it allows you to designate what happens if a TOD beneficiary should die before you, for instance. Talk to your stockbroker about this titling arrangement if you think it might be a good idea for you — but talk to your lawyer first.
- Beneficiary deeds for real estate — this one is available in only about a dozen states, but Arizona is one of those. It is like a POD or TOD designation for real estate — including your home. It only works on real estate located in Arizona or one of the other beneficiary deed states. The beneficiary deed conveys no current interest in your property, but avoids probate and vests directly in your beneficiary upon recording of your death certificate. You and your spouse can, for example, own your home as community property with rights of survivorship but upon the second death automatically transfer to your children in equal shares (with provisions about what happens if one of them should not survive both of you) upon the second death. We have written about beneficiary deeds in Arizona before, and our earlier explanations are still valid (even though our newsletter style has been updated).
What’s wrong with these beneficiary-based devices? Two things, at least: (1) they don’t provide for what happens if you make life changes that effectively adjust your estate plan (if, for instance, you live off of one account that was to go to one or two children, and thereby reduce their share of the estate) and (2) they make it hard to change your estate plan (if you decide to disinherit a child, for instance, you have to make sure to change all of the operative documents and titles). But in the right circumstance, beneficiary designations can effectively transfer your estate without probate — they act as a sort of a “poor man’s” trust.
Trusts. Which gets us to the most efficient way to avoid probate for most people — the living trust. To be clear, the trust doesn’t really avoid probate at all — but your trust assets do not have to go through the probate process and so anything you have transferred during life to the trust will avoid probate. It is the “funding” of the trust that avoids probate, not the trust itself.
So there you have it. Probate avoidance in a nutshell. But wait — what’s not on that list? Did you notice? There is so much confusion about the missing item, which does not avoid probate:
Making a will. Preparing and signing your will is a good thing to do. It avoids intestate succession, which might not be right for you. It designates who will be appointed by the court to act as your personal representative. It can name the person who will be your children’s (or your incapacitated spouse’s) guardian. It can even create a trust. But it does not avoid probate.
Your will is instead instructions to the probate court. It has no effect unless and until it is admitted to probate, which another way of saying that a court has determined that it really is your last will. Clients frequently say: “thank goodness I’ve signed my will today. Now I can sleep better knowing my children won’t have to go through probate.” We say: “sit down. We have some more talking to do. Obviously we have failed to get you to understand the distinction between wills and probate avoidance.” Then we talk about living trusts.
Did that help? Do you have a better idea for probate avoidance (we’ve left a couple of less common methods off)? We’d love to hear from you.