When you die, you leave an estate of property, which can be classified as either probate or nonprobate property, that must be distributed to living beneficiaries. Probate property is distributed under the supervision of the probate court, and includes property distributed according to a will and property distributed under intestacy, which is the default distribution scheme defined by state law that applies when the decedent left no will or did not include all his property in the will. Nonprobate property is any property that is distributed to beneficiaries outside of probate.
Since probate is time-consuming and expensive, many people have sought ways to transfer property outside of probate upon their death. Although living trusts remain the best means of transferring property outside of probate, other methods — nonprobate transfers — are easier to implement. You can mix and match these nonprobate transfers with a trust or a will. However, people who may have large debts or liabilities may benefit by using probate, since creditors are given a certain period of time to submit a claim, after which claims would be forever barred.
Property Passed by Contract
Some property can be passed outside of probate through a contract. Retirement plans and many financial accounts are passed by this method. Most of these contracts allow the designation of both a primary beneficiary and a contingent beneficiary. The contingent beneficiary would only inherit if the primary beneficiary dies before the testator. Some contracts allow more than one primary beneficiary to be named, in which case, the property is divided equally among them. The primary beneficiaries have a right of survivorship, so if one or more of them dies before the testator, then the remaining primary beneficiaries will inherit before any contingent beneficiaries.
Payable-on-death (POD) financial accounts allow you to name a beneficiary on a form provided by the financial institution where you have your account, which can include bank accounts, including savings, checking, or certificate of the of deposit accounts; so-called Totten trusts are an example of this; some government securities, including treasury bonds, treasury bills, and treasury notes. The beneficiary has no right to the money while you are alive so you can do whatever you want with it; however, it can be frozen by the state if there is an estate tax due. In some states, you may have to notify the beneficiary that you have set up an account for them. The bank can let you know if beneficiary notification is a requirement.
Transfer-on-death (TOD) registration for stocks and bonds are allowed in every state except Texas, where you can register securities, including mutual funds, on a TOD form simply by designating the beneficiary to receive the securities upon your death. The brokerage company or other financial institution can provide you with the form.
Transfer-on-death real estate deeds, that are better properly signed, notarized, and recorded in the county where the real estate is located, allows real estate owners to transfer their property after death to a named beneficiary. The TOD deed must clearly state that the transfer to the beneficiary is not to take effect until your death.
Some states — California, Connecticut, Kansas, Missouri, and Ohio — also allow registration forms for motor vehicles to have a named beneficiary in case the owner dies.
Individual retirement accounts, such as IRAs, Roth IRAs, SEP-IRAs, and 401(k) plans allow you to designate the beneficiary. However, with the exception of a Roth IRA, you must begin withdrawing money from your account after reaching 72, or pay a penalty since the government needs to start collecting taxes from your account at some point. You are not required withdraw money from Roth IRA, because the money has already been taxed.
The proceeds of life insurance are income tax-free and can pay the debts and expenses of the estate. However, it should be paid directly to a family member rather than to the estate to avoid probate and estate tax. To avoid estate tax on the life insurance proceeds, you can transfer ownership of the policy to a beneficiary or to an irrevocable life insurance trust. However, the life insurance policy must be transferred at least 3 years before the death of the insured to avoid its inclusion in the estate.
Joint tenancy is the ownership of property in equal shares by more than one person. In most states, a joint tenancy can be created by listing themselves as joint tenants with rights of survivorship on the deed or property title. If a joint tenant dies, then his share is divided equally among the remaining joint tenants without going through probate. However, probate is not avoided if all joint tenants die simultaneously. Because the joint tenants agree to a right of survivorship, they cannot dispose of their share in a will, but they can transfer their share while they are alive to someone else, who will then own the property interest as a tenant in common rather than as a joint tenant, and the new owner will be able to dispose of his share in his will.
Joint tenancy has several drawbacks. If 1 or more joint owners become incapacitated, then the other joint tenants cannot sell or mortgage the property unless the incapacitated joint tenants are represented by a conservator or someone else with a durable power of attorney that can make decisions for them. The other drawbacks of a joint tenancy arise if 1 of the joint tenants contributes much more to the property than the others, which can incur a gift tax liability for the contributor.
Joint tenancy is restricted in some states:
- a transfer to a married couple in Oregon and Tennessee creates a tenancy by the entirety instead of a joint tenancy;
- a transfer to a couple in Wisconsin creates community property with rights of survivorship;
- Alaska only allows a married couple to be joint tenants;
- Texas requires a separate written agreement.
Tenancy by the entirety, available in about half of the states, is like joint tenancy but is limited to married couples. The transfer of ownership requires the consent of both spouses. Hence, incapacity of 1 spouse may make it difficult to transfer or mortgage the property. A tenancy by the entirety differs from a joint tenancy with right of survivorship in that the creditors of one spouse cannot attach any interest in the property, because both spouses are legally considered to own the entire property. On the other hand, the creditor of one owner can attach the debtor's interest in jointly held property.
Community property with a right of survivorship avoids probate but is only available to married couples in Alaska, Arizona, California (available also to register partners), Nevada, and Wisconsin. However, Texas and Washington require that the couple sign a written agreement that their community property has the right of survivorship, or, in Wisconsin, a marital property agreement that allows a testamentary trust or other entity to inherit marital property without probate, including when the 2nd spouse dies.
Lifetime gifts can reduce estate taxes, but you lose the control and benefit of the property. However, to avoid the federal gift tax, the value of the gift per individual per year must be less than the gift tax exemption.
Many states have simplified procedures for transferring property if the value of the total estate or the value of the property transferred is less than a statutory amount, thereby lessening the time and expense of the probate court's involvement or by eliminating the supervision of the probate court entirely.
One such procedure allows beneficiaries to claim property with an affidavit, where the inheritor signs, under oath, a document stating that he is entitled to certain property either under a will or under state law. Then the inheritor can present the affidavit along with a copy of the death certificate to the institution holding the property, such as a bank. Some states also allow a surviving spouse to inherit property without probate if it is less than a certain value.
Most states also have simplified probate for small estates that allows people to do it themselves. In some states, the value of the property that actually passes through probate must be below the statutory maximum. In other states, the value of the entire estate, including property transferred by nonprobate methods, must be below the statutory maximum, so that lawyers and the probate court can extract fees from the wealthier estates, as has been their tradition throughout the centuries. (After all, if only a certain value of property passes through probate, why should it matter how large the rest of the estate is?)