Avoiding probate can save money, and speed up the process of transferring assets to the beneficiaries of a person who has died. This article explains the probate process, and outline various ways to avoid probate.
What does probate mean?
Probate is a legal procedure, where a court oversees the distribution of property of a person who has died. Many states have a specialized probate court. The court appoints someone to ensure that all debts are properly paid, and that the remaining property is transferred to the proper parties. If there is no will, the property is distributed to the deceased person’s next of kin, as determined by the state’s probate law. To probate a will, the property is distributed in the manner set forth in the will. It is important to understand that a will does not avoid probate. Some states provide a simplified procedure for estates below a certain value, or where all of the property is left to a surviving spouse.
Probate costs and drawbacks
There are several costs involved in a probate. A filing fee must be paid to the court, which varies by state. Many states require the payment of some form of tax, typically based upon the value of the assets in the probate estate, usually referred to as a death tax or an inheritance tax. Some states only assess the tax if the value of the estate exceeds a certain amount. If a probate attorney is hired, there are attorney’s fees, which may be based on an hourly rate, a percentage of the value of the estate, or a combination of these. There may be fees charged by the person appointed to handle the estate (called a personal representative or an executor). It may also be necessary to hire an accountant.
A probate can take months, or even years, to complete. For an average estate it will take from about six months to two years. The longer it takes, the more it costs. If any heirs contest a will, things get more time-consuming and expensive.
Probate makes the deceased person’s financial situation a matter of public record. This includes the nature and extent of the assets, the person’s debts, and who will get the assets.
Giving away property
One simple way to avoid probate is to transfer property before you die. You can’t give away all of your property because you will need some of it to live on. However, gifts can be part of an overall estate plan. The main drawback to a gift is that you no longer have the use of the property. If you intend for the gift to be the recipient’s share of your estate, and you don’t clearly state this in writing, the recipient may be able to claim a share of any property that needs to be probated. Also, if a gift exceeds a certain amount, the federal gift tax may apply.
Property that is jointly owned with survivorship rights will avoid probate. Real estate, motor vehicles, and financial accounts may be held jointly. If one owner dies, title passes automatically to the remaining owner. There are three types of joint ownership with survivorship rights:
(1) Joint tenancy with rights of survivorship.
(2) Tenancy by the entireties. This is used in some states, and is the same as joint tenancy with rights of survivorship, but it only applies to joint ownership by married couples.
(3) Community property. This form of joint ownership, only for married couples, is only available if you live, or own property, in Alaska, Arizona, California, Idaho, Nevada, Texas, or Wisconsin.
A form of joint ownership that does not avoid probate is tenancy in common, where the interest of a joint owner who dies passes to his or her heirs, and must be probated. If it is not clear that survivorship rights were intended, it will be assumed that a tenancy in common exists.
One drawback to joint ownership is that the person you make a joint owner acquires certain rights. For example, if you make your son a joint owner of your house, your son must agree to the sale or mortgage of the property. If you make him the joint owner of your bank accounts, he has the right to withdraw money, even without your permission. Other possible drawbacks or limitations include:
(1) Upon death of an owner, half (or all) of the asset may be considered part of the deceased person’s estate for estate tax purposes.
(2) Adding another person as an owner may trigger the federal gift tax, if the value of the property exceeds a certain amount.
(3) The property may be subject to judgment creditors, or the claim of a divorcing spouse.
Pay-on-death and transfer-on-death accounts
For bank and financial accounts (including IRAs), it may be possible to designate someone as a beneficiary in the event of death. This is called Pay-On-Death (POD). This is preferable to joint ownership of the account, since the POD beneficiary has no rights in the property until death occurs. Designating a beneficiary for a bank account is simply a matter of filling out a form. Upon death the funds are paid to the beneficiary and the account is closed.
A beneficiary designation for property other than funds in bank and financial accounts is called Transfer-On-Death (TOD), since title is being transferred. All states except Louisiana and Texas have adopted the Uniform Transfer-on-Death Securities Registration Act for stocks, bonds, and other securities. As of 2015, beneficiary designations for motor vehicles are allowed in Arizona, Arkansas, California, Connecticut, Delaware, Illinois, Indiana, Kansas, Missouri, Nebraska, Nevada, Ohio, Vermont, and Virginia. Designations for real estate are permitted in Alaska, Arizona, Arkansas, Colorado, the District of Columbia, Hawaii, Illinois, Indiana, Kansas, Minnesota, Missouri, Montana, Nebraska, Nevada, New Mexico, North Dakota, Ohio, Oklahoma, Oregon, South Dakota, Virginia, Washington, West Virginia, Wisconsin, and Wyoming.
Another way to avoid probate is with a living trust. This is usually the best choice for avoiding probate if you have a large estate, or many beneficiaries. To avoid probate, most people create a living trust commonly called a revocable living trust. It is “revocable” because you may revoke the trust at any time. People sometimes create an irrevocable living trust (most often for Medicaid planning), which also avoids probate, but requires the person creating it to give up the right to revoke it.
To create a revocable living trust you execute a living trust document which creates the living trust as a separate entity from you. The title of property is transferred from you to the living trust, and you become the trustee. While you are still alive, you control the property. You manage the property the same as if it was still in your name (sell or mortgage it, for example), and may acquire more property and add it to the trust. Upon death, a person you appoint as your successor trustee assures that the property is transferred to the people you designate as trust beneficiaries. This transfer does not require probate. The successor trustee would also manage the trust if you become mentally incapacitated.
Attorney’s fees for setting up a trust are substantially more than for drafting a will. However, depending upon the value and complexity of your property, the legal fees in setting up a living trust can be less than the cost of probate. Part of the attorney’s fees will involve transferring title of property to the trust, which is an essential part of avoiding probate.
IRAs. There are ways to transfer an IRA and extend the time when the funds must be distributed (and become taxable to the beneficiary). This is especially important if the beneficiary is not a spouse. A living trust must contain certain language to accomplish this tax advantage.
If you are married. A spouse has rights in various types of property, especially real estate and IRAs. If you are married, you may not be able to name someone other than your spouse as a beneficiary or joint owner.
Same-sex couples. In states that do not recognize same-sex marriage, tenancy by the entireties or community property are not available. However, joint tenancy with rights of survivorship would still be an option, as well as the other methods of probate avoidance.
One or more of these methods may be used to avoid probate. Which method, or combination of methods, is best for you will depend upon your particular circumstances.
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