All the Ways You Can Avoid Probate

Avoiding probate often is a major estate planning goal, but most people don’t learn all the strategies available. In probate, a deceased person’s estate is administered and distributed according to state and local law. The process ensures debts are paid and legal title to assets passes as the decedent wanted, or according to state law if the decedent didn’t have a valid will.

There are good reasons people want to avoid probate. Probate can tie up the estate for months or longer and can cause the estate to incur extra expenses. While some states and localities streamlined the process, at least for less valuable estates, for most estates probate still has delays plus extra expenses and work. The estate administrator usually is required to appear before the court or a clerk one or more times unless a local attorney is hired to manage the process.

Also, a probated estate is a public record anyone can review. Many people don’t want others to know the details of their estate and how it was distributed.

Fortunately, you can structure the estate so that all or most of it passes to your loved ones without probate. Generally, assets whose title passes to the next owner by a contract or operation of law are exempt from probate. The living trust is the most well- known way to avoid probate.

All assets owned by the trust are distributed to new owners as described in the trust agreement. The probate court isn’t involved. I’ve discussed living trusts in detail in past issues of Retirement Watch (see our December 2021 and January 2020 issues) and won’t discuss them more here.

Retirement accounts, such as IRAs and 401(k)s, avoid probate. The beneficiary designation form on file with the account administrator or trustee determines who inherits them.

Your will and the probate court usually aren’t involved. Life insurance benefits and annuities are distributed to beneficiaries named in the contract. The insurance company pays the benefits after receiving the death certificate and other documents.

There’s no involvement of the probate court, unless the estate is a beneficiary. Joint accounts and joint title are widely used ways to avoid probate. Married couples can own real estate or financial accounts through joint tenancy with right of survivorship.

Some states also allow a tenancy in the entirety for real estate. In either case, the spouses both own the property while both are alive. The surviving spouse automatically takes full title after the other spouse passes away. Joint title to property also can be established between non-spouses. It’s fairly common for an older person to create a joint account with a younger person at a financial institution.

The younger person automatically inherits the account when the older person passes away, without the need for probate. In addition, if the older person is unable to manage his or her affairs at some point, the younger person can manage the older person’s finances without the need for a power of attorney.

But there are downsides. All joint owners have equal rights to the property. A joint owner can take withdrawals from the account or change how it is invested without the consent of the other owner.

Joint accounts are one of the most common means through which financial fraud and abuse are inflicted on older people. Also, once joint title is established you can’t make a change in owner- ship without the consent of the other joint owner.

The person who inherits full title of an account through joint title also might not receive some of the tax benefits, such as increasing the tax basis of assets, available when assets are inherited in other ways. Joint title is the least desirable way to avoid probate when the joint owners aren’t spouses.

A transfer on death provision (TOD) is another way to avoid probate. Most financial institutions now have TODs in their new account applications and allow the designation to be changed or added later.

TODs, also known as payable on death (POD) ac- counts, are allowed in real estate deeds in many states. The transfer of a financial account with a TOD is similar to the transfer of a retirement account.

After the original owner passes away, the account is turned over to the beneficiary or put in his or her name once the financial institution receives the death certificate and some other information. The probate court isn’t involved.

You can name multiple beneficiaries and specify the percentage of the account each will inherit. Unlike a joint account, the beneficiaries under a TOD have no rights in or access to the account while the owner is alive. Also, you can change the beneficiaries or make other changes at any time without anyone’s approval or knowledge, as long as you are mentally competent.

A TOD account is not safe from the estate’s creditors in most states. Also if you are married, in most states the surviving spouse has rights to the TOD account before any other beneficiaries do. You might come across the traditional term Totten trust. That’s another name for a TOD or POD account, though there’s no trust involved.

Be sure your executor or the beneficiaries know about the account and the TOD provision. Otherwise, it could be lost. Two other ways to avoid probate are the life estate and the variation known generally as a ladybird deed.

They most frequently are used with real estate, but the life estate can be used with most types of property. An owner of property can split the title into a life estate and remainder estate. The life estate holder usually is the current owner, and one or more beneficiaries have the remainder estate.

The life estate holder has unlimited use of the property during his or her life but generally can’t sell, give, or encumber the property without the consent of the remainder owner. The life estate holder also can’t change the remainder owner or alter the remainder owner’s rights without the consent of the remainder owner.

After the life estate owner passes away, the remainder interest owner receives full title to the property by operation of law without going to the probate court. The ladybird deed variation is very much like a TOD for real estate.

The initial owner has unlimited control of the property. Without asking the remainder owner or beneficiary, the initial owner can sell, give, or encumber the property and can terminate the rights of the remainder owner without the remainder owner’s consent. If the initial owner sells the property, the sale proceeds don’t have to be shared with the remainder owner.

There’s a trick to ladybird deeds regarding the property’s insurance. Legal title to the property passes to the beneficiary as soon as the initial owner dies. If the beneficiary wasn’t named as an insured in the insurance on the property, the beneficiary isn’t covered if something happens to the property shortly after the initial owner dies.

In a recent case, a niece inherited a home under a ladybird deed. But the ex-wife of the deceased owner set fire to the property a few days after the owner died. The niece wasn’t named as an insured in the deceased owner’s homeowner’s policy and hadn’t yet obtained new coverage, so she received no insurance benefits. Also, the deceased’s estate couldn’t claim benefits, because it no longer had a legal interest in the property.

Lesson: All owners and beneficiaries in a ladybird deed should have insurance coverage. Another possible way to avoid probate is to create an inheritance agreement, a contract in which the owner agrees another will inherit the property after the owner’s death.

The contracts most frequently are used among business co-owners. A court isn’t involved unless there’s a disagreement about the contract. The agreements, however, can be cumbersome, and there aren’t many court precedents for them, especially when business co-owners aren’t involved. It is better to use one of the other methods to avoid probate.

When using any method of avoiding probate, it’s important to understand the potential gift tax consequences. Adding someone as a joint owner to your account or creating a remainder interest for someone in your property is a gift.

The gift tax consequences depend on the amount of the gift. If the value of the gift exceeds the $16,000 annual gift tax exclusion, a gift tax return probably has to be filed. The value of the gift exceeding $16,000 will reduce your lifetime estate and gift tax credit, or exemption. There will be gift taxes due only after your lifetime exemption is exhausted. There are no gift tax consequences for naming someone as the beneficiary of a living trust, retirement account, life insurance policy, annuity, TOD or lady-bird deed.

Those are all incomplete gifts, because the beneficiary designation can be changed at any time and the beneficiary has no rights until the property owner passes away.

Keep in mind that avoiding probate is different from excluding assets from your taxable estate. The assets you have lifetime ownership or use of are likely to be included in your estate for tax purposes, even when they avoid probate.