Estate Planning

Do beneficiary or joint accounts avoid probate?

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Whether intentionally or not, some people are of the opinion that a trust is not necessary either because they have someone else named on their account or because there is a beneficiary.

So does beneficiary-designated accounts or joint accounts still go through probate?

Well, it depends. Keep reading…

Beneficiary Accounts

If an asset has a beneficiary attached to it, it will not go through probate if the following factors are satisfied: (1) the named beneficiary is a living adult; and (2) the beneficiary can be located. For example, a retirement account or life insurance policy may name a beneficiary. If the beneficiary is a living adult who can be located, the money in the account belongs solely to the beneficiary and no probate is necessary as long as the institution holding the money can distribute the funds to the beneficiary. Potential problems with beneficiary designations include:

  • Minor beneficiaries: If the beneficiary is your minor child, there will be a probate court proceeding called a “guardianship of the estate” because a minor child cannot “own” the asset until he or she has reached 18 years old. A guardianship of the estate is problematic because the court will be involved on an annual basis.
  • Incapacity issue: If you are incapacitated, you effectively will be unable to access your funds because of your incapacity, and your beneficiary also will be unable to access your funds because you are still alive.
  • Unintended beneficiaries: Sometimes people name beneficiaries and forget to update contact them. Often, folks will still have ex-spouses named as beneficiaries instead of children. In those cases, the funds legally belong to the beneficiary. In other situations, beneficiary information is not updated and so institutions cannot locate the intended person(s).
  • Inability to control distributions: One of the downsides of beneficiary designations is that the beneficiaries can do whatever they want with the funds. While this may be fine for some people, for younger beneficiaries it can be a recipe for disaster as it’s not uncommon for younger beneficiaries to lose their inheritances rather quickly.
  • If beneficiary predeceases: If the primary beneficiary is alive at the time the owner of the account dies, but then the primary beneficiary dies before the distribution of the asset, there is a probate! Many people – including advisors – mistakenly assume that the asset will automatically go to the contingent beneficiary named on the account, but that only occurs if the primary beneficiary pre-deceased the owner. For a detailed article on a related issue, read our article, “What Happens When a Beneficiary Dies?

Joint Ownership

If an asset is owned jointly, it will not go through probate if the following factors are satisfied: (1) the named account holder is a living adult; (2) the person can be located; and (3) if the joint ownership consists of either joint tenancy or community property. For example, a home owned by husband and wife as community property with rights of survivorship would avoid a probate if one of them died. A bank account owned as joint tenants would also avoid probate if only one of them died. Potential problems with joint ownership include:

  • Tenants-in-common: If a home is owned as a tenant-in-common, then the death of one tenant-in-common leads to a probate of his or her share. This is a big difference between joint tenancy, in which the share of the decedent will automatically pass to the other joint tenants.
  • Unintended consequences: Many times a parent names one of their children to be a co-owner on a bank account (or home). The parent thinks that if something happens, the child will take over the asset. The asset however now legally belongs to the child when the parent dies. The child is not required legally to share the asset with any of their siblings because it now legally belongs to that specific child only. Even in situations where the child wants to share the money in the account, or the home, with their siblings, they will run into gift tax problems because they might have to make taxable, reportable gifts to their siblings, which ends up being more work than originally envisioned by the parent.
  • Simultaneous death: If all the owners were traveling and got into an accident at the same time, there could be a probate. Thus, naming a child on an account usually isn’t “safer” if you’re worried about accidents or anything of the sort.
  • Loss of step-up in basis: One of the most common reasons never to add a child, or anyone else, to an account as an owner is that the person added may lose the ability to take a step-up in basis on the assets when the original owner dies. For more information on how this works, please read, How the Step-Up in Basis Works
  • Additional Liability: Adding someone, like a child, to your asset increases your potential liability risk in case that person gets sued, divorced, or declares bankruptcy, to name just a few reasons.
  • Filing a gift tax return: By adding someone to your asset, you likely are making a taxable gift, that should be reported on Form 709, if the amount being gifted is more than $15,000. Many people neglect to think of this and instead just say, “But I’m adding my child to the deed of my home only in case something happens to me.” This does not matter. By adding someone to your asset, you are making a taxable gift and this has its own repercussions.

To avoid these added risks, it is recommended to use a trust whenever possible. This avoids probate and is better from a tax standpoint, control standpoint, and efficiency standpoint.

Please contact our law firm if we can help you design the best plan for you and your family.

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