How Estate Planners Can Effectively Manage Non-Probate Assets

Effective estate planning involves a careful consideration of assets and their distribution to ensure intended beneficiaries experience a seamless transfer of assets when the time comes. Understanding the difference between probate and non-probate assets is the first step in this process.

What Are Non-Probate Assets?

Unlike probate assets, which may require court approval and oversight for distribution, non-probate assets transfer directly to designated beneficiaries or co-owners outside the probate court’s jurisdiction. Non-probate assets are those assets disposed of at death by operation of law or contract, and these assets often constitute the majority of a decedent’s wealth.

Operation of law: Non-probate assets that transfer by operation of law include property held in joint tenancy with rights of survivorship or assets already titled in trust.

Operation of Contract: Non-probate assets that transfer by operation of contract include accounts that transfer or are payable upon death, such as life insurance and retirement accounts (assuming these assets have named beneficiaries).

It’s important to remember that the decedent’s gross estate is distinct from the decedent’s probate estate, and many non-probate assets are still includable in the gross estate of the decedent. Even if an asset does not go through probate, it may still need to be reported for estate tax or income tax purposes.

Potential Post-Mortem Issues With Non-Probate Assets

Avoiding probate is a central tenet of modern estate planning; as a result, the value of the decedent’s non-probate assets is often significantly greater than the probate assets. Because the subject non-probate assets pass directly to the beneficiaries, lack of attention to their disposition during the planning process can lead to conflicts post mortem. And because executors, and, in some cases, trustees, lack authority over non-probate assets, these fiduciaries are not able to step in to smooth over pre-death planning oversights. Finally, there are the tax implications: Non-probate assets are often includible in the gross estate for estate tax purposes, potentially causing liquidity problems when the available assets (including those held in the decedent’s revocable trust) are insufficient to cover federal and state estate taxes.

Fortunately, estate planners can follow an established process to identify non-probate assets and carefully plan for the implications of their transfer.

The Comprehensive Asset Inventory

Effective administration begins with a detailed inventory of all probate and non-probate assets as soon as practicable after the decedent’s death. It can take weeks and, in some cases, months to obtain the requisite information to properly report non-probate assets on the decedent’s estate tax return, which is due nine months from the date of death. Failure to identify all of the decedent’s assets early in the process can delay the preparation of the estate tax return, which in turn may cause the client to suffer failure-to-file and failure-to-pay penalties at the state and federal levels.

In creating the comprehensive inventory, the advisor must carefully document ownership and authority. Each asset must be documented with its:

• Ownership (is it included or excluded from the gross estate)
• Date-of-death value
• Beneficiaries (individuals/trusts, etc.)
• Transfer mechanism (claim form, surviving joint tenancy affidavit, etc.)

The Importance of Beneficiary Designation

Beneficiary designations determine who receives insurance proceeds and retirement assets, impacting probate, taxation, and future estate tax mitigation.

Life Insurance

Insurance proceeds with valid beneficiary designations are non-probate assets. But without pre-death planning, the death-benefit value will be included in the gross estate of the decedent. It’s also important to be aware that the failure to name a beneficiary on a policy (or if all named beneficiaries pre-decease the decedent) may cause it to be paid out to the probate estate or even a surviving spouse, either of which may not conform to the decedent’s overall plan. Whatever the circumstances, the representative must obtain a Form 712 to report the value of the policy for estate tax purposes.

Retirement Accounts

Like life insurance, retirement accounts with valid beneficiary designations are non-probate assets and their date-of-death value must be reported for estate tax purposes. It’s important to be aware that there is no step-up in basis for retirement accounts, so planners must carefully evaluate their disposition when advising clients. Failure to designate a beneficiary will cause the account to become a probate asset, which, under the SECURE Act, carries with it complex income tax consequences.

Transfer Mechanism: Both life insurance and retirement accounts are transferred to the designated beneficiary through the use of claim forms. Each administrator has unique forms that should be reviewed and prepared carefully.

Payable on Death (POD)/Transferrable on Death (TOD) Accounts

As with life insurance and retirement accounts, accounts that are payable or transferrable on death (POD or TOD) are included in the decedent’s gross estate. Advisors must obtain a date-of-death value for each POD or TOD account. It’s important to know that securities in a POD/TOD account will generally receive a step-up in basis, but retirement accounts do not.

Transfer Mechanism: POD and TOD accounts may be distributed relatively easily. Most institutions require only the decedent’s death certificate. Know Your Customer (KYC)-compliant personal information may be required to release funds to the beneficiary. Because POD/TOD accounts bypass probate, they also bypass the decedent’s estate plan documents (the will and often the inter vivos revocable trust into which the will pours the probate assets into). The direct payout feature of these accounts can affect and alter the dynamics among beneficiaries, heirs, and legatees.

Joint Tenancy and Transfer-on-Death Instruments

Joint Tenancy and Transfer-on-Death Instruments (TODI) are estate planning tools used to transfer property directly to beneficiaries upon death, bypassing probate court.

Joint property vests by operation of law, vesting in the surviving joint tenant immediately upon death. If the surviving joint tenant is the decedent’s surviving spouse, one half of the date-of-death value of the real estate is included in the estate of the surviving spouse. If the surviving joint tenant is not the spouse, the full date-of-death value of the jointly held real estate is included in the decedent’s gross estate. Real property is still ascribed its fair-market value and receives a step-up in basis as of the decedent’s death with respect to the value included in the decedent’s gross estate.

A TODI is a recorded instrument that names a beneficiary to automatically receive the property when the owner dies, bypassing probate.

There are strict rules for proving the validity of a TODI:

• They carry the same formalities as an inter vivos deed
• They must state that the transfer to the designated beneficiary is to occur at the owner’s death.
• They must be recorded before the owner’s death in the public records in the office of the recorder of the county or counties in which any part of the real property is located.

Like other non-probate assets, real estate passing pursuant to joint tenancy or a TODI does not follow the decedent’s core estate plan documents. Pre-death planning should include an analysis of the ultimate beneficiaries of all decedent’s property, especially given that real property is sometimes the largest asset of a decedent’s estate.

Implementing A Repeatable Roadmap

Successful non-probate administration relies on carefully identifying, collecting, coordinating, and administering assets to reduce risk and ensure a smooth estate closure.

Facing questions about non-probate assets? Reach out to Grant Hendricks, Alyx Durachta, or another member of LP’s Trusts & Estates Group.