Many individuals rely on non-probate planning tools to avoid the probate process. While there are many advantages in doing this, using a non-probate transfer without fully understanding the consequences can sometimes lead to more harm than good.
We may not all be wealthy or have significant assets, but we can still have specific desires as to how our property gets distributed when we pass away. We might also want to save as much money as we can and have our heirs receive what's rightfully theirs as quickly as possible. As a result, we can choose how we want our assets to be handled following our death. But practically all of our choices will fall under either probate or non-probate means.
This latter approach is popular as it avoids probate court and the accompanying legal proceedings. But why would anyone want to do this? And are there any risks to taking this approach to estate planning? In this article, we'll answer both these questions. But before we do, let's examine how the probate process and non-probate transfers work.
Probate refers to the legal process where a court will oversee the administrative details following someone's death. This includes handling financial and legal matters such as:
- Confirming the validity of a will
- Determining the value of the deceased's property
- Pay the debts and tax bills of the deceased
- Distributing property to heirs or other designated recipients
This process is usually uneventful and mostly administrative. Sometimes there are will disputes or questions as to who gets what. But most of the time, it's a matter of making sure the right paperwork gets completed by certain deadlines and the appropriate bills and fees get paid.
Despite the relatively boring nature of the probate process, there are several reasons why some people go to great lengths to avoid it.
First, it's not cheap. Depending on the size of the estate, there will be a host of fees that can chip away at the money the heirs eventually receive. Some of these fees include:
- Court fees
- Executor fees
- Attorney fees
- Accounting fees
- Appraisal fees
When the probate process is complete the estate could lose as much as 3% to 8% of its value in fees.
Second, the probate process can be slow. At a minimum, it will usually take at least a few months. But taking up to a year or two is common. During that time, the assets can be held up by the court until certain aspects of the probate process can finish. For example, someone might file a claim that a piece of property should go to them despite a will saying otherwise. Or an asset may need to be sold to pay off a debt.
Then there's the lack of privacy. Probate court records and proceedings are generally of public record. Therefore, anyone can see what assets were left and who they might be going to. The lack of privacy can be particularly troublesome if there is a legal dispute and a family's “dirty laundry” gets aired out in public.
Meanwhile, probate makes it harder to avoid certain creditors. During most probate proceedings, creditors must get notice that the debtor has passed away. They then get a certain amount of time to assert a claim with the estate to have their debts paid. In some cases, it might be in the estate's best interest to avoid probate and avoid the opportunity for creditors to step in and collect their debts.
Non-probate transfers are transfers of property not subject to the probate process. There are many different types of non-probate property and non-probate transfers. Most of them can be grouped into the following three categories:
- Living trusts
- Joint ownership
- Beneficiary designations or registrations
Living trusts are trusts that are created and funded during the grantor's lifetime. One of the most popular types of living trusts used for non-probate transfers is the revocable living trust.
This trust allows someone to create a trust and place his or her property inside the trust so the trust becomes the new legal owner. But this individual can also be the trustee and continue to use the property as if they own it outright. Once the individual dies, the successor trustee steps in and is bound to manage the property inside the trust according to the individual's wishes. All the while, the property inside the trust avoids probate.
Joint ownership can take several forms and go by multiple names, depending on the state. But the key feature of these legal constructs is that two or more people own the same property. Then when one of the joint owners dies, the property automatically stays with the surviving joint owner(s) so no probate process is necessary. Common examples of joint ownership that can avoid probate are:
- Joint tenancy with right of survivorship
- Joint ownership with right of survivorship
- Community property with right of survivorship
- Tenancy by the entirety
Finally, we have beneficiary designations. These are special contingent assignments on a variety of property, such as bank accounts, life insurance, vehicle registrations, real estate deeds or investment accounts that explain who will receive the funds in that account (or the property itself) when the owner dies.
Depending on the financial institution, all the beneficiary needs to do is provide proof of the account holder's death and confirm his or her identity. No probate process is needed.
Non-probate transfers offer an excellent way for individuals to ensure their assets get distributed according to their wishes while avoiding the probate process. But there are some risks and other drawbacks to be aware of when using these non-probate methods.
For instance, in some states, there is a streamlined probate process in place for estates under a certain size. So even though the deceased's estate will go through probate court, the process will go more quickly and cost far less money. Depending on the non-probate transfer tools being used, there may be little savings by taking the non-probate transfer route.
As for beneficiary designations, several problems could arise if certain contingencies are not properly accounted for.
First, if the account holder is married and in a community property state, then his or her spouse will automatically have a claim to 50% of the account's assets. This is the case regardless of who is the named beneficiary.
So using a beneficiary designation when married could mean your intended beneficiary gets half of what you wanted them to have. The exception to this is if the assets subject to the beneficiary designation were obtained before marriage or inherited.
Second, if the account is jointly owned, then the named beneficiary cannot gain access to the property until all owners die. What typically happens is that after one joint owner dies, the account goes to the surviving joint owner(s) with nothing getting transferred to any beneficiaries.
Third, beneficiary designations usually cannot prevent all of a deceased's assets from avoiding probate. And even if they could, it may not always be the best decision. This is because if an estate has no money or property, there will be nothing available during the probate process to pay the necessary fees and any applicable creditors.
Fourth, depending on the state, the beneficiary must survive the account owner by a certain period of time. In many states, it is 120 hours. We can use a hypothetical situation to illustrate how this could be a potential problem.
Let's say Bob owns a savings account worth $50,000 and lives in a state with a 120-hour beneficiary survivor rule. Bob also has a very wealthy adult child that he no longer talks to or likes.
Bob lives with his girlfriend and her child and helps raise and support them both. Bob lists his girlfriend as the sole beneficiary of his savings account with the intent that if he dies before her, she can use the money from the account to help support herself and her child.
One day, Bob and his girlfriend are driving and get into a fatal accident. Bob dies instantly and his girlfriend is rushed to the hospital for emergency surgery. Sadly, she dies 36 hours later due to complications from the surgery.
Guess who gets the $50,000? Not Bob's girlfriend (or her estate), as she was unable to survive Bob by the necessary 120 hours. Instead, the $50,000 will get distributed per the terms of his state's intestate statute.
Most likely, this means his estranged son will get the money. Bob's girlfriend's daughter may be able to argue that she has a claim to the money, but she will likely face a very challenging and expensive legal battle should Bob's son decide to play hardball.
This unfortunate scenario could have been avoided if Bob created a trust instead of relying on the beneficiary designation of his savings account.
Another risk of using non-probate transfers is that it could lead to future trouble with creditors. Remember, the probate process requires the notification of the deceased's creditors so they can make a claim against the estate to have their debts paid. And if the creditors don't take this action within a certain period of time, the debts get wiped away for good even if the debts are never paid.
However, if a particular piece of property subject to a lien or other debt obligation goes through a non-probate transfer process, the creditor may have the ability to go after that property well after the owner has passed away and the probate process (if applicable) is concluded.
In some cases, the creditor could learn of the property owner's death one or two years after it occurs. The creditor then tracks down to the property and sees that it's owned by someone else.
However, if the original debt is still valid, the creditor could file a lawsuit against the new owner and claim that the property, or at least part of it, belongs to the creditor to pay off the debt. If there are any penalties or accrued interest, the creditor may end up getting more money than they would have gotten if the property went through the probate process and the creditor properly notified.
Another risk when using non-probate transfer tools is that you may need an extra level of trust in surviving individuals to carry out your wishes. For example, let's say you have a home that you jointly own with one of your children. And this ownership includes the right of survivorship.
While you're alive, you need help taking care of yourself, so your child lives with you to help with daily living tasks. But after you die, you want your child to sell the home and split the proceeds evenly among all of your four children.
Your final day comes and you pass away. The child that was living with you has a falling out with the rest of your children and decides not to sell the home and offers nothing to the rest of your children. The child that took care of you until your died can do this because you and this child were joint owners and the moment you passed away, they became sole owner of the home.
The purpose of this article is not to say that the probate process is the best method of distributing your assets after you pass away. There are many non-probate transfer tools available that can allow you to avoid probate and still have your final wishes carried out as intended.
However, you need to know exactly what you're getting into when you choose to transfer a particular asset using a non-probate method. The beneficiary designation might work for your neighbor or coworker. But in your situation, a living trust might be a better option. Yet you won't know that until you speak to an experienced estate planning lawyer and explain your estate planning objectives.
If you're not careful, what you think is a way of saving time and money can end up costing your estate many times over. But the most tragic thing is not having your property go where you want them to go. This could lead to leaving your loved ones struggling to carry out your wishes or even worse, unable to financially survive once you're gone.
Non-probate transfer tools are great and certainly have a place in any estate plan. This is true whether you want to avoid probate or not. But they carry tremendous risks if you try using them utilizing do-it-yourself tools instead of a qualified attorney.