In a previous blog article, we explored the importance of ensuring that beneficiary designations are kept up to date and consistent with your overall estate plan. We often think of beneficiary designations in the context of life insurance policies or retirement plans, such as 401(k)s and IRAs. It is also possible to name beneficiaries on bank accounts and investment accounts using a payable on death (POD) or transfer on death (TOD) registration. In this blog we delve into how these registrations work and some of the pitfalls to watch out for. 

What is a POD/TOD registration, and how does it work?

A POD or TOD registration is the equivalent of a beneficiary designation on assets that do not typically require a named beneficiary. A POD designation is generally used for bank accounts and certificates of deposit where the account holds cash. A TOD is usually used for brokerage accounts and investment securities such as stocks and bonds. An easy way to remember the difference is to think of cash being paid out to a beneficiary, while securities are more likely to be transferred to a beneficiary at the death of an owner.  

Adding a POD/TOD registration to an individually owned account results in the account passing directly to the named beneficiary(ies) at the owner’s death, while avoiding probate. Since probate can be costly, time-consuming, and open to the public, avoiding the probate process is considered a benefit. Beneficiaries may be an individual, a charity, a business, or a trust, and multiple beneficiaries may be named. A contingent beneficiary may also be named in case the primary beneficiary predeceases the account owner.  

A majority of states, but not Massachusetts or New Hampshire, allow a TOD deed for real estate. A TOD deed, also known as a beneficiary deed, transfers real estate at the death of the owner to a named beneficiary or beneficiaries, usually without having to go through the probate process. The complexities of using a TOD deed are beyond the scope of this article. 

What’s the difference between a POD/TOD account and a joint account?

POD/TOD accounts and accounts titled as joint tenancy with rights of survivorship (JTWROS) both result in direct transfer at death to a beneficiary/joint owner without going through probate. JTWROS is a form of asset ownership. For example, if you own an account with your spouse as JTWROS, then both of you are considered equal owners of the account and may each access and control the asset during your lifetime. In contrast, a POD/TOD registration is a beneficiary designation. During your lifetime, you retain complete ownership of and control over the account. You can delete or change the POD/TOD designation at any time until your death. The beneficiary has no rights to or control over the assets during your lifetime.  

Joint ownership takes precedence over a POD/TOD designation. If a joint account has a POD/TOD beneficiary, upon the death of one joint owner, the survivor takes full ownership. Only after both joint owners have passed away does the POD/TOD beneficiary receive the assets. Note that both designations overrule any instructions made in a will or a trust.  

While POD/TOD and JTWROS can both remove an account from your probate estate, neither will remove an account from your gross estate for estate tax purposes. Usually, 50% of a JTWROS account is includible in your gross estate, while 100% of a POD/TOD account is includible. Relatedly, typically 50% of a JTWROS account receives a step-up in cost basis, while 100% of a POD/TOD account receives a step-up. The percentage of inclusion and step-up for a joint account may depend on who the joint owners are and who contributed to the account. 

Potential problems with POD/TOD registrations

The main cause of problems that arise from POD/TOD registrations is the lack of coordination with your overall estate plan. Assets covered by a POD/TOD designation will pass directly to the named beneficiary(ies) at your death and are not subject to any instructions you may leave in a will or a trust.  

Moreover, establishing POD or TOD on an account is a simple process, requiring only a signature on a form. It is common for banks and brokerage firms to include optional POD/TOD forms with their new account paperwork. This encourages people to establish POD/TOD beneficiary designations potentially outside of the thoughtful review process that exists when designing an estate plan. POD/TOD forms do not require an attorney, witnesses, or a notary, as is the case when executing a will or a trust document, and there’s no competency check to ensure that someone is not signing under undue influence. Without careful planning, using POD/TOD designations can have unintended consequences.  

1. Liquidity Issues

   Assets passing to beneficiaries outside of the will or trust are generally not readily available to help pay final expenses (funeral, medical, credit card, etc.) or estate taxes. Bank accounts and investment accounts tend to be the most liquid assets. If they are subject to POD/TOD registration, then they will be paid out to beneficiaries upon proof of the owner’s death. If the remaining estate consists of illiquid real estate or a closely held business, POD/TOD beneficiaries may be called upon to return cash to the estate to meet liquidity needs. If beneficiaries are not in agreement, any cost savings from probate avoidance will quickly be wiped out by the expense of attorneys drafting and enforcing a consent agreement to recover funds. 

2. Bequests

   Liquidity issues may also affect the estate’s ability to pay pre-residuary bequests to individuals or charities. If the estate doesn’t have liquid cash to cover such bequests, those bequests won’t be paid. If POD/TOD beneficiaries step up and make gifts to cover the bequests out of assets received, they could encounter gift tax consequences. 

3. Estate Plan Obstruction

   If an estate plan involves estate tax planning, such as funding credit shelter trusts, marital trusts, and even generation-skipping transfer trusts, then a POD/TOD designation may frustrate the plan by circumventing instructions in the will and trust. 

4. Updates Required

   As circumstances change, estate plans need to be updated. When you rely on PODs and TODs on multiple accounts for your estate plan, you may need to make many changes to beneficiary designations.  Missing one or more of these changes can result in the wrong person receiving assets after your death.  Often a better alternative is to title your accounts in a revocable trust and to update the terms of the trust when necessary.  

5. Incapacity

   A comprehensive estate plan anticipates and provides for incapacity as well as death. A POD/TOD is not a substitute for an estate plan, because it only dictates where an asset goes at death. The beneficiary has no ability to manage assets on your behalf during your lifetime, as is the case under a general durable power of attorney or as trustee of a trust. 

6. Asset Values

   If different beneficiaries are named for different assets, then asset value fluctuation over time could lead to one beneficiary receiving much more or less than intended. 

7. Asset Protection

   Assets passing outright to beneficiaries have no asset protection. They are not protected from creditors, from an ex-spouse in divorce, or from attachment by Medicaid or other government benefit programs. Alternatively, trusts may be drafted to provide such protection. 

8. Probate

   POD/TOD accounts do not always avoid probate. If your beneficiary should predecease you, and you did not name a contingent beneficiary, the account would go through probate. Use of a revocable trust instead of a POD/TOD registration is a more reliable way to avoid probate while ensuring that assets pass to the appropriate beneficiary(ies). 

9. Minor Beneficiary

   Depending on state law, it may or may not be possible to name a minor child as a POD/TOD beneficiary. Even when it is possible to name a minor beneficiary, a guardian or court-appointed conservator would need to manage any inherited assets on behalf of the minor until they reached the age of majority. Using a trust to manage assets for minor children is a far superior approach. 

Conclusion

While POD/TOD account registrations can offer a straightforward way to pass assets to beneficiaries without the need for probate, they come with several potential pitfalls that can complicate estate planning. It is crucial to be aware of these hazards and consider the specific circumstances of your estate. Consulting with a professional financial planner and estate attorney can help ensure that your estate plan is comprehensive and that your assets are distributed according to your wishes. The use of a revocable trust can address many of the possible risks inherent in POD/TOD registrations.  

Remember, careful planning today can prevent significant challenges for your loved ones in the future. Milestone does not provide legal advice, but we can coordinate with your estate attorney to ensure that your estate plan is properly implemented, and that asset titling aligns with your desired outcome. If you need assistance with estate planning or have questions about POD/TOD accounts, please reach out to our team for guidance.