Non-retirement investment accounts are often set up with wealth management firms. When the account is set up, there is an option to put a beneficiary designation on the account and oftentimes the account is then designated as a TOD (Transfer on Death) or a POD (Payable on Death) account. With this type of designation, it allows the asset to transfer to the named beneficiaries at death without the necessity of probate. The customary advice is that this is an efficient way to transfer the asset and save some administrative complexity. Contrary to this customary advice, it is my belief that most non-retirement investment accounts are better off without a beneficiary designation.
Of course, there are exceptions to every rule, but I think that this rule should be switched – investment accounts should be set up without Transfer on Death designations. The purported efficiency and simplicity offered by the automatic transfer on death designation can actually have the opposite effect and complicate the administration of an estate after death.
Estate’s Liquidity Offers the Ability to Maximize Benefits to Heirs
Your estate is made up of all the things that you own. If an asset does not have a beneficiary designation, then it becomes part of the pool of assets covered by the Will for distribution to your heirs. Sometimes assets need liquidity to maximize the value to the heirs. As an example, let’s imagine you own a house at death. And, if you can pay $20,000 for upgrades to the house, then the house can sell for $40,000 more. A savvy person would conclude that it is in the best interest of all beneficiaries to pay the money. But that payment requires that the estate have the liquidity to pay for those upgrades. Alternatively, consider the same example of a house and a death in November – a notoriously difficult time to sell a house. Perhaps the estate would be better off waiting until the following summer to list and sell the house and reap the benefits of a higher selling price. This would require sufficient liquidity to pay for the ongoing costs of the upkeep to the house. In either case, setting up a Transfer on Death designation deprives the estate of that liquidity.
Estate’s Liquidity Offers More Options for Distribution
The additional liquidity can also offer better distribution options to the heirs. Assume two assets: a house valued at $300k and an investment account valued at $300k. Assume further that two heirs share equally in the assets per the terms of a Will. If the investment account is a TOD variety, then each heir gets the $150k and each heir gets an undivided ½ interest in the house (resulting in a difficult fractionalized ownership scenario). Maybe it would be better to be able to divide assets based on the desires of the heirs. If all the assets are controlled by the Will (and not a TOD designation), the Executor could assign the $300k house to the heir that wants it and the remaining $300k of liquid assets to the heir that didn’t care to own the house.
Creditor claims are more easily dispatched
After death, a creditor can make a claim against a deceased person’s estate for up to two years. If the claim is a valid one, the estate must pay that claim. It is much easier to pay those valid claims when the estate has some liquidity to pull from to satisfy the bill.
Centralized management of expenses
Expenses naturally pop up after a death. Those expenses might be the expenses associated with the last illness or injury causing death. They might be the costs of the funeral or cemetery plot. They might be ongoing expenses to heat and cool the house or pay property taxes. Again, having a ready pool of liquidity offers flexibility in the administration of a typical estate.
If the assets were distributed to the beneficiaries through a TOD designation, couldn’t the executor just get the necessary money from the beneficiaries? Yes, that is a distinct possibility. But wouldn’t an estate be better served if one person was in charge of all the assets and had control of the liquidity and could properly distribute the remainder to the heirs after the payment of all reasonable and necessary expenses? That is what is offered by allowing the liquidity to flow into the estate by not having a beneficiary designation.
Fancy Will Works Better
People pay a lot of money to put in place a Will to control the disposition of assets upon death. By adding a Transfer on Death designation, it moves the asset out from under the control of the Will. This may not align with the intended distribution scheme outlined in that Will. Indeed, more often than not, the designation works to thwart the estate plan by creating disparate distribution plans. For example, the Will might include specific bequests (e.g. $10,000 to Charity X) or some kind of testamentary trust. Without sufficient assets existing in the probate estate, the estate might have trouble paying those intended beneficiaries.
Retirement Accounts are Different
Note that retirement accounts are different. There are specific income tax benefits to naming beneficiaries on retirement accounts, so they pass outside of the rest of the estate. Those assets are not explored by this article.
The opinions voiced in this material are for general information only and not intended to provide specific advice or recommendations for any individual or entity. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.
Securities offered through LPL Financial, member FINRA/SIPC. Investment advice offered through Cornerstone Wealth Strategies, Inc., a registered investment advisor and separate entity from LPL Financial.
