Transfer on Death vs Trust
A living trust is generally better than transfer on death for the majority of people because it provides more comprehensive estate planning, covers all asset types, protects against incapacity, and provides greater control over who gets what. Transfer on death is best for simple estates with very few assets and a single heir, but trusts are more flexible, anonymous, and protective for complex situations.
Introduction to Estate Planning Options
When you take a seat to determine how your property goes to loved ones when you pass away, you have a critical choice among different estate planning tools. Transfer on death designs and living trusts are two of the more well-known methods of avoiding probate. Understanding how they differ can help you make an informed choice for your family's case.
Both transfer on death and trust options allow your assets to skip the probate process, which is costly and time-consuming. But they work in very different manners and have different benefits depending on your situation. This complete guide will help you decide when each option is right for you and which might be best for your estate plan.
What Is Transfer on Death?
How It Works
Transfer on death, or TOD, is a handy estate planning tool which allows you to name beneficiaries who will inherit automatically upon your passing certain assets. This can be used for many varieties of accounts and property, including bank accounts, investment accounts, and real estate in certain states.
Ownership and Control
Under a transfer on death arrangement, you retain complete ownership and control of your assets during your lifetime. You can use, invest, or give away these assets as you desire. The transfer on death identification only comes into play when you pass away, at which point the assets pass automatically to your named beneficiaries without the need for probate court.
Transfer on Death Deeds
Transfer on death deeds for real estate work similarly. These legal documents, also known as beneficiary deeds, allow property owners to name someone who will inherit their real estate upon death. The property owner retains full control during their lifetime and can revoke or change the transfer on death deed at any time.
Creating a TOD
Creating transfer on death designations is usually simple. With bank accounts, you would usually just have to sign a form at the bank or financial institution. For property, you will need to sign and file a transfer on death deed with the proper county office where the property resides.
What Is a Living Trust?
Definition and Purpose
A living trust, or a revocable trust, is a more complex estate planning tool that maintains assets in your name for your benefit during your lifetime and leaves them to inheritors at the time of your death. When you create a living trust, you are the grantor and retitle your property into the trust, although you typically remain the trustee and maintain full power.
Instructions and Control
The trust contract gives you very detailed instructions on what is to be done with your property during your lifetime and how it is to be distributed upon your death. You can also alter or revoke the trust at any time during your life and while you are competent. Upon your death, a successor trustee takes over and distributes the property according to your specifications.
Asset Coverage
Living trusts can hold any type of asset, including real property, bank accounts, investment accounts, business interests, and personalty. It is this holistic mentality that allows you to package your estate planning together in one document and keep all trust assets from probate.
Incapacity Protection
In contrast to transfer on death arrangements, living trusts also provide important protection if you are incapacitated. Your successor trustee may step in and manage trust assets if you are unable to, without needing court-appointed conservatorship or guardianship.
Key Differences Between Transfer on Death and Trusts
Complexity and Scope
The fundamental difference between trusts and transfer on death is the complexity and scope. Transfer on death designations are applied asset by asset, with separate designations for each property or account. Trusts can encompass a variety of types of assets within a single comprehensive document.
State Availability
State availability is yet another important difference. Trusts are available in all states at the state level, whereas transfer on death deeds for real property exist only in approximately half of the states. This limitation may be problematic if you own property in more than one state or you're considering a move to a state that lacks transfer on death deeds.
Flexibility and Control
Flexibility and control between these options also differ extensively. Transfer on death designations provide you with little flexibility in how and when beneficiaries receive assets. After your passing, the assets go to specified beneficiaries with no limitation. Trusts provide much more flexibility so you can leave conditions on distributions, make staggered distributions over time, or establish ongoing management for beneficiaries who may not be ready to handle large inheritances.
Privacy Considerations
Privacy considerations vary between these approaches as well. Transfer on death designations typically provide privacy in that they do not require court involvement. However, trusts provide even greater protection of privacy since trust instruments do not typically have to be filed in any public registry or published in records.
Advantages of Transfer on Death
Transfer on death designations offer a number of compelling advantages, primarily for those with simple estate planning needs.
Convenience and Affordability
The primary benefit is convenience and affordability. Creating transfer on death designations typically requires little paperwork and expense compared to creating an entire trust.
Implementation Speed
Implementation speed is another advantage. You can frequently place transfer on death beneficiaries on bank accounts in an instant by visiting your bank or by phoning your bank. Transfer on death is thus a suitable option for people who want to hasten probate evasion without extensive legal forms.
Immediate Access for Beneficiaries
Transfer on death designations also open up immediate access to assets for beneficiaries upon your passing. Once your death certificate is presented to the financial institution or filed with the county for real estate, assets can transfer promptly to your beneficiaries without delay for probate court proceedings.
Simplicity in Updates
Simplicity of transfer on death also makes it easy to change beneficiaries. You can usually modify or revoke transfer on death designations at any time by amending your beneficiary forms or recording a new transfer on death deed.
Disadvantages of Transfer on Death
Even though they are easy, transfer on death designations come with significant limitations that will create problems for you in your beneficiaries.
Lack of Contingency Planning
The largest limitation is the lack of contingency planning. If your named beneficiary dies ahead of you and you fail to update your designations, the property will still go through probate.
No Protection for Minors
Transfer on death designations also provide no protection for minor beneficiaries. If you name a minor child as a beneficiary, the property could require court-appointed custodial management until the child is a legal adult. This is the very court intervention you were trying to avoid.
No Asset Protection
The other significant weakness is a lack of asset protection. Assets that are transferred through transfer on death nominations become property absolute in the hands of the beneficiaries, subject to creditor attack, lawsuits, divorce litigation, and poor money choices.
Coordination Problems
Transfer on death appointments can also lead to coordination problems in your estate plan. Since each asset transfers independently, you might unintentionally make unfair distributions to your beneficiaries. You may have one child as the beneficiary of your largest account and have another child as the beneficiary of a smaller account so that the distribution is not according to your intended equal treatment.
Insurance Coverage Concerns
Insurance coverage could be a concern with transfer on death deeds in property. Some courts have ruled that homeowner's insurance does not necessarily cover beneficiaries who inherit property using transfer on death deeds, and even if beneficiaries are insured, things can go wrong if there are problems.
Advantages of Living Trusts
Living trusts give complete estate planning benefits that go far beyond simple probate avoidance.
Protection Against Incapacity
One of the best advantages is protection if you become incapacitated. If you cannot manage for yourself due to illness or injury, your successor trustee can step in right away to manage trust property without court involvement.
Control Over Asset Distributions
Trusts also provide more control over asset distributions. You can create conditions for distributions, provide staggered payments over a span of years, or create ongoing trusts for beneficiaries. This comes in handy when beneficiaries are minors, beneficiaries have special needs, or beneficiaries won't know how to spend money wisely.
Asset Protection
Asset protection is another significant benefit of trusts. Assets held in trusts can be shielded from the creditors of beneficiaries, divorce courts, and other legal actions if well planned. Certain trusts also offer protection against your creditors or long-term care expenses.
Comprehensive Estate Planning
Trusts deliver comprehensive estate planning by allowing you to address all of your assets in a single vehicle. Coordination guarantees your estate plan works the way you want it to and reduces the likelihood of overlooked assets or unintended consequences.
Privacy Protection
Privacy protection is stronger with trusts generally since trust documents do not have to be filed in public records. The distribution of trust assets may be completely confidential, as opposed to probate proceedings which become part of the public record.
Disadvantages of Living Trusts
The principal drawback of living trusts is their cost and complexity.
Higher Costs
Creating an involved trust often requires the services of an attorney and is far more costly than simple transfer on death plans. The up-front expense can range from a few thousand dollars to significantly greater amounts in more complex cases.
Maintenance Requirements
Maintenance provisions also make trusts more complicated than transfer on death arrangements. You must remember to roll new assets into the trust as you acquire them, and you will have to revise trust documents as laws are revised or your circumstances shift.
Administrative Complexity
Administrative complexity in your life may also be inconvenient. Even though you are in charge as trustee, you must comply with trust formalities and maintain proper records. There are some banks that also request more paper work when dealing with trust assets.
Funding Challenges
Funding the trust is another likely snag. Establishing trust documents is not enough; you must actually put the ownership of assets in the trust. You must not, as this will render the purpose of the trust useless and result in probate of the unfunded assets.
When Transfer on Death Makes Sense
Transfer on death is best for those with simple estate planning situations. In situations where you have fewer assets, basic beneficiary designations, and adult beneficiaries who are capable of handling immediate inheritance, transfer on death may be adequate protection.
Individual Asset Ownership
Individual asset ownership tends to work well in conjunction with transfer on death. If your primary asset is your home and you have one adult child that you want to leave it to, a transfer on death deed may provide sufficient protection without the expense of a trust.
Temporary Protection
Transfer on death can also be used as a temporary solution while you create a more comprehensive estate plan. In the event that you need immediate probate protection but have not yet had a chance to establish a trust, transfer on death designations can provide temporary protection.
Small Estates
Tiny estates where the expense of a trust would be out of proportion with the worth of property may also be helped by transfer on death strategies. Yet you should take a close look at whether the restrictions balance the cost benefits.
When a Living Trust Is Better
Living trusts typically make more sense for people who have complicated family relationships, large estates, or specific distribution goals.
Beneficiaries with Special Needs
If you have minor kids, special needs recipients, or worries about the financial management of recipients, a trust is sure to provide advantages unavailable through transfer on death."
Multiple Asset Types
A number of assets also fit into trust planning. If you possess property, investment accounts, business interests, and personal property, a trust can coordinate the control and distribution of all these assets according to a master plan.
Incapacity Planning
Incapacity planning strongly prefers trusts over transfer on death. If you're concerned about your ability to manage assets if you end up disabled or ill, a trust enables easy transfer to successor management without court involvement.
Geographic Considerations
Geographic considerations enter into the picture as well. If you own property in more than one state or might move into a state that does not recognize transfer on death deeds, a trust provides more solid protection from state to state.
Cost Comparison Analysis
TOD Costs
Transfer on death designations are inexpensive to initiate. Transfer on death forms are normally free from most financial institutions, and transfer on death deeds only require a few hundred dollars of legal and recording fees.
Trust Costs
Living trusts involve a greater upfront cost. Trust creation attorney fees range from $1,500 to $5,000 or more, based on complexity and location. This expense must be weighed against the possible savings in probate fees and other benefits trusts give you.
Long-Term Cost Benefits
Long-term expense considerations make trusts a better choice even at higher upfront costs. Probate proceedings can cost 3-7% of estate value in legal fees, court costs, and administrative expenses. Trust costs can be reimbursed many times on larger estates in avoided probate.
Maintenance Costs
Ongoing trust maintenance costs are typically minor if you do routine functions yourself. Others prefer paying periodic fees for professional trust maintenance or periodic legal updates.
Tax Considerations
Tax Treatment
Transfer on death and revocable living trusts both provide similar tax treatment during your lifetime and for estate tax payment purposes. Neither approach provides you income tax benefits during your life, and both make the assets included in your taxable estate for federal estate tax purposes.
Stepped-Up Basis
Both techniques are governed by the same stepped-up basis rules. Beneficiaries receive a stepped-up tax basis to fair market value at your death, perhaps skipping capital gains taxation on appreciated assets.
Estate Tax Planning
Estate tax planning varies only for very large estates. While revocable trusts don't provide estate tax benefits, they can be structured to coordinate with other estate tax planning strategies. Transfer on death designations don't enjoy that flexibility.
Income Tax for Beneficiaries
Income tax planning for beneficiaries may be more favorable to trusts in some situations. Trusts have more control over when to make taxable distributions, which may help beneficiaries with improved tax bracket management.
State Law Variations
TOD Availability by State
Transfer on death deed availability varies significantly from state to state. Approximately 30 states allow transfer on death deeds for properties, while the other states reject this practice. This limitation can be problematic if you move or own properties in multiple states.
Trust Laws Across States
Trust laws are more standardized across states, though there are minimal differences in specific rules and procedures. Trusts created in a state are usually recognized in other states, providing people with greater mobility who might relocate.
Special State Requirements
Some states also impose special requirements or limitations for transfer on death deeds that don't apply to trusts. California, for example, limits transfer on death deeds to particular types of residential property and requires certain form compliance.
Regulation and Licensing
State professional regulation and licensing also vary. Some states regulate more heavily the drafting of transfer on death deeds than others, which can affect the price and availability of assistance.
Common Estate Planning Scenarios
Young Families
Young families with young children effectively always benefit more from trusts than on death transfers. Trusts can provide long-term planning for children's inheritances and interlink with life insurance and other estate planning strategies.
Stepfamilies
Stepfamilies with children from prior marriages often need the flexibility provided by trusts. Trusts can provide fair treatment of several family members and provide for surviving spouses while preserving inheritances intact for children.
Business Owners
Business owners typically need trust planning to resolve business succession, generate liquidity to fund estate taxes, and coordinate business and personal asset transfers. Transfer on death designations rarely provide adequate protection for business interests.
Special Needs Beneficiaries
Special needs beneficiaries require delicate trust planning to preserve government benefits and leave additional care. Transfer on death designations tend to disqualify beneficiaries from essential programs unintentionally.
Making the Right Choice for Your Situation
The decision between trust planning and transfer on death depends on your individual facts, family situation, and estate plan goals. Consider the complexity of your holdings, the sophistication of your recipients, and long-term planning goals.
Consultation with a professional is often useful in making this decision. Estate planning attorneys can help you understand how each would work for you and what pitfalls you might not consider.
Remember that estate planning is not a one-time decision. Your situation may change over the years, and you can often start with less detailed approaches and then progress to more complete planning as your circumstances evolve.
Conclusion
While transfer on death designations are simple and inexpensive ways of probate avoidance, living trusts provide better protection and flexibility for most estate planning situations. Transfer on death suits those with simple assets, simple beneficiary provisions, and minimal estate planning needs.
Living trusts are generally a good idea for anyone who has significant assets, complex family situations, minors to take care of, or incapacity planning concerns. The increased cost and complexity of trusts are generally worth it for the increased protection and flexibility they provide.
Consider your personal situation carefully and don't hesitate to get the advice of professionals. What is best for you is based on your own situation, and by taking a well-informed step today, you can spare your family lots of time, money, and frustration in the future. Through transfer on death, living trust, or some combination of measures, the solution is to take action to protect your family's financial security.
