As an estate planner and probate practitioner, it is commonplace to see people take advantage of payable on death designations on their bank accounts, and other assets, by naming their loved ones as beneficiaries. Beneficiary designations have several advantages and should be utilized under the right circumstances, but they too can create some traps for the unwary.
Advantages of a Payable on Death Designation
1. Avoid the Cost of Probate
It is well known that the primary benefit of using a beneficiary designation is to avoid probate on the transfer of an asset from the person who held title to the asset upon death, to the named beneficiary. A transfer of wealth through a beneficiary designation can occur rather quickly after death and for little to no cost, especially compared to a probate proceeding.
2. POD Designations Can Be Revoked and/or Modified
Another advantage to a beneficiary designation is that it is revocable and amendable by the account holder until death (or incapacity). In addition, the designated beneficiary has no right to the funds in the subject account or control over those funds while the account owner is alive. This means the account owner has no risk that his or her funds might be subject to the creditors of a designated beneficiary or that the beneficiary can access the funds behind the account holder’s back.
This is in stark contrast to jointly held accounts, (often used by elderly, single people as substitutes for powers of attorney) where the account is subject to the creditors of all account holders and unilateral control by either account holder.
3. Increased Insurance Protection
Finally, beneficiary designations also have the added benefit of increasing the amount of money insured under FDIC rules, but this topic is beyond the scope of this article.
However, there is a downside to beneficiary designations in the context of other ways a person can transfer wealth without probate.
Problems When POD Beneficiaries are Minors
First and foremost, beneficiary designations should be avoided when minors are involved. Often single parents list minors as beneficiaries on life insurance or asset accounts and couples list minors as contingent beneficiaries after a spouse. This is a natural and instinctive thing to do. However, even though a minor beneficiary will inherit probate-free any funds for which he or she was named a beneficiary, the cost of obtaining the funds for the minor could be significant.
Financial institutions don’t release money to minors. Indeed, often the financial institution requires a court order or evidence of a guardianship so that institution can release the funds to a suitable adult caretaker. These court proceedings are expensive and can require the outlay of costs and legal fees for the duration of a child’s minority.
In California, the filing fee to initiate a guardianship case, or even obtain an order to take control of money under the Uniform Transfers to Minors Act is over $400, and that doesn’t include any attorney’s fees or other costs.
This requirement isn’t waived by a financial institution just because one is a minor’s parent (i.e. an ex-spouse died leaving insurance proceeds to one’s six year old child). If there are multiple minors, the cost and fees can really skyrocket. In addition, often to avoid the annual cost of a bond in a guardianship case, parents elect to hold the minor’s funds in a blocked account. This requires additional time and money just to get access to the funds to spend for the minor’s benefit and doesn’t allow for any flexibility in investing the minor’s funds. Indeed, often these funds sit for years in low interest, albeit safe, money market accounts.
Finally, guardianships conclude at 18, meaning when a child turns 18, he or she suddenly will have access to all the wealth while their hormones are raging and their maturity level could put the funds at great risk.
What to do? A better solution to avoiding probate when minors are involved is to establish a trust and name the trust (or trustee) the beneficiary of the subject account. A trustee (by definition an adult) will have no problem obtaining the funds from the financial institution without any expensive proceeding.
The trustee will then be at liberty and obligated to manage the funds for the minor according to the dictates of the trust and the needs of the minor without court interference. Through a trust, one can establish that funds be managed for the minor until an age well beyond 18, the age guardianships conclude. A trust can prevent the distribution of funds to a minor upon adulthood if the child has a chemical dependency problem or creditor issues.
Contrast that to a simple beneficiary designation which acts like a blank check a minor can cash at 18.
Access to Cash for Administrative Expenses: Trusts & POD Accounts
Beneficiary designations should not act as a trust substitute in the case of adults either. I often sit down with clients to draft a trust and discover that the clients have listed their adult children as beneficiaries on all their accounts. This approach is better than exposing those beneficiaries to a probate proceeding at death, but it is imprudent to maintain all your accounts with pay on death beneficiaries when you have a trust. Here’s why.
Just like a car needs oil to keep the engine running, a trust needs cash, especially after death. When one dies, if all his or her accounts will be divided between several adult beneficiaries, none of those beneficiaries will have access to that cash to pay for the decedent’s bills and other expenses that arise when settling a trust estate. Often, in these circumstances, one beneficiary ends up spending their own money (assuming a beneficiary has enough money) from personal funds to administer the trust, and then chasing reimbursement from his or her siblings.
Sometimes parents attempt to avoid this by making one child a joint account holder so that the child will have immediate access to money, but this too creates a downside (creditors, potential for abuse). In addition, legally the child joint tenant owns the property in the joint account at death and might not easily distribute the balance to his or her siblings like the parent intended.
To avoid these complications, it is much wiser simply to have the trust take ownership of at least some accounts so that there is enough cash in the trust to use for administration expenses. This way, no one beneficiary is spending personal funds, there is no lag time to access the money, and those funds aren’t available to the beneficiary’s creditors or subject to the beneficiary’s control while the parent is managing his or her affairs.
Once a trust is funded with enough cash, there is little downside to using beneficiary designations to transfer the balance of one’s wealth to adult beneficiaries.
Advice to Conclude
In conclusion, one should be very leery of making minors beneficiaries of assets accounts and should always make sure their living trust possesses enough cash to meet expected administrative costs.