Chapter 3 Probate and How to Dodge It

Probing Probate: What You Should Know

Probate is a term that is used in several different ways. Probate can refer to the act of presenting a will to a court officer for filing — such as, to “probate” a will. But in a more general sense, probate refers to the method by which your estate is administered and processed through the legal system after you die.

The probate process helps you transfer your estate in an orderly and supervised manner. Your estate must be dispersed in a certain manner, as outlined in this chapter (your debts and taxes paid before your beneficiaries receive their inheritance, for example). Think of the probate process as the “script” that guides the orderly transfer of your estate according to the rules.

Many people think that probate applies to you only if you have a will. Wrong! Your estate will be probated whether or not you have a will:

With a valid will: If you have a valid will, then your will determines how your estate is transferred during probate and to whom.
Without a valid will: If you don’t have a will, or if you die partially intestate, where only part of your estate is covered by a valid will (see Book 2, Chapter 4), the laws where you live specify who gets what parts of your estate.

So read on for a few important points about probate that you need to know.

The probate process

Even though you won’t be around when your estate goes through probate (after all, you’ll be dead), you need to understand how the probate process works. At the most basic levels, the probate process involves two steps:

Pays debts you owe
Transfers assets to your beneficiaries

A state court called the probate court oversees the probate process. Because probate courts are state courts and not federal courts, the processes they follow may vary from one state to another. Yet despite their differences, these courts all pretty much follow the same basic processes and steps, which typically include

Swearing in your personal representative
Notifying heirs, creditors, and the public that you are, indeed, dead
Inventorying your property
Distributing your estate (including paying bills and any taxes)

Swearing in your personal representative

In your will, you name who you want to be your personal representative — that is, the person in charge of your estate after you die. However, the court determines the personal representative for your estate if

You die without a will.
You have a will but for some reason didn’t specify who you want to be your personal representative.
The person you selected has died or for some reason can’t serve — and you didn’t “bring in someone from the bullpen” to replace your original choice.

A family member, such as your spouse or an adult child, can request that the court appoint him or her as the personal representative for your estate. Regardless of who is finally selected, the court gives your personal representative official rights to handle your estate’s affairs. As evidence that this person has the authority to act on behalf of your estate, the court gives your personal representative a certified document called the Letters of Administration or Letters Testamentary.

In either case, the personal representative named in your will or determined by the court has to first be formally appointed by the court before officially entering into office (the term that’s used). Usually this involves that the personal representative take an oath of office, after which he or she will then receive the official documentation showing his or her status (the Letters of Administration or Letters Testamentary just mentioned).

Your personal representative files a document called a Petition for Probate of Will and Appointment of Personal Representative with the probate court. This petition begins the probate process. If you have a will, the probate court issues an order admitting your will to probate. Basically, the court acknowledges your will’s validity.

Notifying creditors and the public

Some state laws require your personal representative to publish a death notice in your local paper. The death notice serves as a public notice of your estate’s probate and enables people who think they have an interest in your estate (such as creditors) to file a claim against your estate within a specified time period.

The notice is part of the process to make the matters of your estate part of the public record. Some people view the general public’s ability to review your private estate matters as one of probate’s disadvantages, as discussed later in this chapter.

Inventorying your property

The personal representative must inventory the different types of property — real and personal — that make up your estate so that your estate value can be determined. This inventory is important for a couple of reasons:

To make sure you left enough to cover your debts and distributions to beneficiaries: If your estate doesn’t meet the monetary obligations of both your estate creditors and your property transfers to your beneficiaries, it’s subject to abatement statutes, meaning that one or more beneficiaries may receive less than you had wanted or even nothing at all.
To ensure that all property is accounted for: Your personal representative is in charge of collecting and inventorying your estate’s assets to make sure that all property is available for distributing at the end of the probate process. (Your beneficiaries, of course, will want to know what assets are in your estate.) If property is missing or not in your ownership at the time of your death, ademption statutes become relevant. These statutes determine whether a replacement asset or cash equivalent should replace the missing property intended for your beneficiary.

You should already have a pretty good idea of what your estate is worth (see Book 5, Chapter 2 for details) so that you can make intelligent choices for your estate plan. Obviously, your personal representative needs to know this information, too. So make sure that your personal representative has easy access to the list that shows what your estate includes and what your assets are worth. Even a slightly out-of-date list can serve as a starting point so that your personal representative doesn’t have to create an inventory from scratch.

Distributing the estate

The final step in the probate process is the distribution of your estate property. In other words, everyone (ideally) — both your creditors and your heirs — gets what’s coming to them.

Creditors that have a valid claim are likely to be paid in the following order (though the order varies from state to state):

Estate administration costs (legal advertising, appraisal fees, and so on)
Family allowances
Funeral expenses
Taxes and debt
All remaining claims

Whatever’s left after your creditors get their money is distributed to your heirs or to the beneficiaries you named in your will. If you died without a will, the laws in your state determine how your property is distributed.

If probate proceeds according to plan and all notices and communications are properly handled, your personal representative is usually protected against any subsequent, late-arriving claims. Your personal representative will be protected after some specified time period expires.

Some complicating factors to the probate process

Some probate processes can be relatively straightforward, while others can be particularly complicated depending on how complicated an estate is. The following sections describe some of the more common complicating factors about probate that you’ll likely encounter.

What’s probated where: Differences between states

All states have probate, and all the types of property that make up your estate — real and personal — may be part of your estate’s probate. Tangible and intangible personal property, like your collectibles and your stock portfolio, are probated in the state where you live, but your real property (your primary home and other real estate, as discussed in Book 5, Chapter 1) is probated where the property is actually located. So if you live on a farm in Pennsylvania and also have a vacation condo in Florida, you’ll have two probates: Pennsylvania probate for your farm and your personal property, and Florida probate for your condo.

If you have more than one probate, the additional probate is called an ancillary probate. Ancillary probate can be costly because your personal representative usually needs to hire an attorney in the state where the real property is located to handle the ancillary administration of probate.

Here’s some good news, though: In many cases, the second state’s courts will legally recognize your personal representative’s authority, and he or she can act on your estate’s behalf in the second state without the necessity of a duplicate probate proceeding.

Probate or not: Differences between types of property

Another common misconception is that probate applies to all of your estate. Actually, probate handles the processing of all assets in your probate estate. Your probate estate is made up of all the property that’s distributed through probate; the remaining property is called nonprobate property.

In a general sense, probate assets are those you own alone, while you own nonprobate assets jointly with others and to whom those assets will pass automatically upon your death. Nonprobate assets also include assets that pass to a named beneficiary: a life insurance policy, for example. Because these nonprobate assets pass to someone automatically, there is no need for probate.

Nonprobate property is your estate’s way of saying, “No, thank you, Mr. Probate. I can handle this part myself!” Nonprobate property includes will substitutes, such as joint tenancy with right of survivorship and living trusts (discussed later in this chapter). Other assets, such as life insurance proceeds, qualified retirement plan benefits, and individual retirement accounts (IRAs) with named beneficiaries are also included.

Knowing the Good, the Bad, and the Ugly of Probate

Be aware of both the positive and negative aspects of probate. Know the pros and cons when you’re planning your estate. You need to determine which assets will require probate and which assets should be nonprobate assets and pass to others through a will substitute.

Probate: The good side

The positive aspects of the probate process include the following:

Fairness
Defined procedures
Protection
Potential tax savings

Life isn’t fair, but probate is

The probate court’s independent role allows for an objective processing of your estate. The probate court regulates all parties involved in the process to make sure that everyone is treated fairly.

For example, the fees paid to attorneys, appraisers, or any other outside parties must be fair and reasonable before they can be paid from your estate.

Defined procedures

The probate process provides an orderly administration of your estate. The probate process guarantees that the probate court will correctly transfer your estate’s property.

Here to protect you

The probate process allows creditors that have valid claims to receive what they are rightfully owed from your estate by proving the validity of their claims. If mechanisms weren’t in place requiring creditors to prove the validity of their claims, your estate could be subject to fraudulent claims.

Imagine a sleazy finance company calling a grieving surviving spouse two days after a funeral and claiming that a loan payment of $5,000 is now two days overdue, but if the payment is made that day by certified check, no late charges will be applied. By requiring creditors to go through the probate process, your estate is mostly protected from these types of fraudulent claims.

Potential tax savings (cha-ching!)

If your estate is in a lower income tax bracket than the beneficiaries who receive the property transfers, tax savings may occur from lower income tax rates. Income tax savings are dependent on current tax rates and thus may not always be advantageous.

Don’t forget that many probate costs are tax deductible and therefore may also reduce death taxes.

Probate: The bad and downright ugly side

Although the positive aspects present a good case for probate, several offsetting negative aspects can make probate an unpleasant process. The negative aspects of probate include the following:

A complicated process
A lack of privacy
Costs
An often-lengthy process

Talk about complicated!

The probate process can cause almost anyone to throw his or her hands toward the heavens and yell “Noooooo!” Multiple, often complicated steps are required before your property transfers can occur. The process often requires numerous hearings and professional assistance — for example, from appraisers to determine value and attorneys simply to get through the process.

Privacy? Forget it

Probate and privacy are polar opposites — the only thing in common is that both begin with p. Privacy typically doesn’t exist in the probate process because after your will is probated, your will then becomes a part of the public record. Additionally, your estate’s inventory and inheritance tax return (if applicable) also becomes parts of the public record. Anyone then can see what your will and estate contain. (“Wow! I didn’t know John had so much money! Let’s try to sell his widow all kinds of shady investments!”) However, some states may offer additional means of privacy for the probate process, so check with your own attorney to understand what your estate will go through some day.

Many people consider their own financial situation, including what their estate contains, to be a private matter. On the other hand, you may not be a private person or you may figure that after you’re dead, you really don’t care about the lack of privacy. In this case, the negative aspect of lack of privacy becomes irrelevant.

Costs can be significant

Everything in life comes with a price. And this old adage applies even in death: Even after you’re gone, the probate process is going to cost your family (or beneficiaries).

Your personal representative is entitled to reasonable compensation that typically ranges between 2 and 5 percent of your gross estate.

Your personal representative also has the option of waiving the fee, and may wish to do so for income tax reasons. You may consider a family member or trusted friend as your personal representative if you know that person will waive the fee, as long as you feel that person is qualified to serve.

Attorneys are also entitled to a reasonable fee that also may range between 2 and 5 percent of the gross estate but may vary depending on factors, such as the complexity of the estate, the attorney’s time spent settling the estate, the attorney’s experience, and other factors. If you add other costs like ancillary probate costs for real property located in another state, the costs of probate add up quickly.

Your beneficiaries need to be patient

Probate may be an orderly and defined process, but it’s anything but fast. The probate process for an uncontested will — meaning no one comes forward to say they have an issue with your will — can easily take between 6 and 24 months. And if your will is contested, the process can be even longer, often years longer.

Typically, your beneficiaries can’t receive any property transfers until all the valid creditors’ claims and taxes have been paid (see “An early payout” sidebar). While your beneficiaries await the completion of your estate’s probate, your estate’s value may decline — maybe even significantly (think bear market and declining stock prices) — leaving your beneficiaries with a lot less than they would have received if the probate process was faster.

Appointing Your Person in Charge

Choose carefully — your personal representative plays the central role in your estate’s administration.

The appointment of your personal representative (and a contingent personal representative as a backup person) is one of the most important actions in your will. Your estate represents your lifetime of work. You, basically, are your own personal representative while you’re alive, but after your death, you need to have someone watch over your estate and make sure that your wishes are carried out. Your personal representative performs this function.

If you don’t designate a personal representative, the probate court may appoint someone for you one way or another. So whether you have a will or not, someone is appointed to handle your estate administration.

Identifying your personal representative’s role

Before you choose someone as your personal representative, double-check that the person understands his or her responsibilities. For that matter, you need to be aware of your personal representative’s responsibilities so that you can select the most appropriate person.

The personal representative follows a critical path method — a road map of the most efficient way to proceed — in the administering of your estate. The steps of the critical path are as follows:

Collecting and inventorying estate property
Managing estate property
Processing creditors’ claims
Filing tax returns and paying taxes
Distributing estate property

Collecting estate assets

Your personal representative first must locate your assets and see what you have in your estate for distribution. Think of this part of your personal representative’s responsibilities as the same as the objective of an Easter egg hunt: to find the eggs and put them in a basket, or in this case, find and gather together all your property.

When collecting and inventorying your assets, your personal representative must notify banks and companies where you have investments of your death, change the address of record on your accounts, and make sure all future communication is through the personal representative. Additionally, your personal representative may need to hire an appraiser to determine your property’s fair market value.

Your personal representative also serves as your accounts receivable coordinator. He or she collects all amounts owed to you, such as your final paycheck, rent from an investment property, or payments from a note or loan. If your estate is still responsible for what you owe to others after you died, you certainly want to make sure that all amounts owed to you will still come into your estate. You’re not letting anyone off the hook for what is owed to you.

Your personal representative also collects payments you’re due and entitled to receive from Social Security (but must also return any inadvertent payments from Social Security after your death) and any life insurance proceeds, if the proceeds are payable to your estate.

Your personal representative must transfer all receivables and any other liquid part of your estate (liquid is a financial term that means readily available assets, such as cash on hand or amounts contained in your bank accounts) to an account in which he or she controls. Through this account, your personal representative pays valid creditors’ claims, fees, taxes, and cash bequests to your beneficiaries after being approved by the probate court.

Your personal representative needs to be careful not to commingle estate assets with his or her own, so he or she must use a separate bank account.

Managing estate property

Because probate doesn’t happen overnight and can drag on for months (or even years in the worst-case scenario), your personal representative manages your estate during the entire probate process. He or she keeps an eye on your estate and its contents until the assets are transferred to your heirs or beneficiaries. Managing your estate includes

Supervising property
Maintaining property
Insuring property
Securing property

For example, if your estate has income-producing investment property, such as a rental house or apartment, the personal representative must manage the property or retain a property management company.

The personal representative needs to insure both real property and tangible personal property, such as jewelry and household furnishings, against loss until the property is transferred to your beneficiaries. Some of your estate property likely had sentimental value to you and to the beneficiary you intended to receive the property. In addition to insurance, your personal representative should physically secure your property to prevent any theft or damage.

Processing creditors’ claims

One of your personal representative’s major tasks is the processing of creditors’ claims. Typically creditors have a specified period (varying from state to state) to file their claims or they lose their ability to receive a part of the estate. Because creditors must typically be paid before any property transfers can occur to beneficiaries, processing creditors’ claims is an important function of the personal representative to keep an already lengthy process moving along.

The personal representative provides notice to creditors of your death by delivering specific notices to the creditors or by general public notice through the newspaper. The notice includes information such as

Case or file number assigned by probate court
Probate court’s location
Personal representative’s contact information
Due date for filing a claim
Documentation needed to process the claim

The personal representative must determine which creditors’ claims are valid — sort of like being one of the celebrity panelists on the old game show To Tell the Truth. If a creditor’s claim is valid and filed within the required time period, the personal representative pays the claim from estate assets. (In fact, sometimes the personal representative must turn to the court to decide whether or not a claim is valid.)

Paying taxes and filing returns

Your personal representative must pay all taxes associated with your estate. Taxes can include any of the following that apply to your estate:

Federal estate taxes
State inheritance and estate taxes
Federal, state, and local income taxes
Gift tax
Generation-skipping tax

Feeling overwhelmed and a little bit guilty about what you’re leaving your personal representative to do? Don’t. Typically, one of your estate-planning team members — your accountant — actually prepares and files all the tax returns. But your personal representative is ultimately responsible to make sure all taxes are paid.

Many of the tax returns have filing date deadlines that are triggered by your date of death. Your personal representative needs to keep track of these deadlines, which means he or she must be organized. The important characteristics to look for when choosing your personal representative are discussed in the section “Deciding who’s eligible to be your personal representative,” later in this chapter.

Distributing estate assets

The final step for your personal representative is your estate’s actual distribution. If you have a will (and hopefully you do), your assets are distributed to your beneficiaries. If you don’t have a will or your will lacks a residuary clause (the clause in your will to deal with whatever property you don’t specifically mention in a giving clause) so that some of your assets don’t have a beneficiary named, your personal representative distributes the assets in accordance with your state’s intestate succession laws.

Even if you have a will, your estate distribution can be affected by other statutes. Your personal representative follows the statutes’ requirements when distributing your estate assets, such as spousal elective shares, homestead statutes, and exempt property awards.

Real property is transferred to your beneficiaries by a deed evidencing legal ownership. Personal property is transferred by either an assignment document to the beneficiary or by a certificate of title if appropriate (for example, a vehicle). For cash distribution, the personal representative provides a check on the estate account payable to your named beneficiary. The property transfers complete the role of your personal representative. The heirs or beneficiaries generally provide receipts as evidence of the distributions, thus releasing the estate and personal representative.

Deciding who’s eligible to be your personal representative

Now you know what your personal representative does in administering your estate. So who can be your personal representative? Practically anyone, but usually it’s one of the following:

Family member
Friend
Business associate
Attorney
Corporate executor (from a bank, for example)

You have a relationship with all these people. The corporate executor is typically a financial institution that you have a financial relationship with, like the trust department of a bank.

Now, whom do you choose? You know their responsibilities as your personal representative. The person — or institution — you select must possess certain characteristics that are needed to perform their duty, such as

Trustworthiness
Honesty
Dependability
Good organization
Common-sense judgment
Fairness
Geographical proximity to the probate court and your property

Your personal representative needs these characteristics to properly administer your estate. For example, your personal representative needs to be fair because one of the hats the personal representative wears is often as a referee to settle disputes that can arise in your estate.

Geographical proximity to your estate property and the probate court is helpful in your estate’s administration. (Long-distance relationships are difficult enough when you’re alive and even more complicated when you’re dead.)

Okay, so you look around and see many choices. (On the other hand, you may think: “If these are my choices, I’m in trouble!”) Many people choose their spouse as their personal representative. After all, you have just spent a lifetime (or it may just feel like a lifetime) with your spouse, and who knows you better? Besides, your spouse most likely is receiving the largest part of your estate.

But the job is time-consuming and tedious. Make sure your spouse and anyone else you are considering understands what is expected. If you have a somewhat complex estate that involves numerous beneficiaries and creditors, inform your personal representative.

Avoiding the pitfalls

You need to be aware of several potential pitfalls when selecting your personal representative, including

Being perceived as favoring one family member over another
Keeping your business going (if applicable to your situation)

If you have three adult children, all about the same age and equally well off financially, you run the risk of slighting two of those children if you select the other as your personal representative. Never mind that pretty much anyone who has ever served as a personal representative agrees that the job is basically one of dealing with details and complications — and plenty of aggravation — for months on end. The other children may conceivably think that the child selected as your personal representative is somehow favored, and this can cause all kinds of family strife and hard feelings for years to come.

If you find that you’re in a similar situation, you may be tempted to designate two or more of your children as co-personal representatives of your estate. Think carefully! You open your estate up to unnecessary disputes and complications if two or more people share that role and then start to use your estate as a battleground for disputes between themselves. As Abe Lincoln (or, for Seinfeld fans, George Costanza) may have put it, “A personal representative divided against itself can’t stand!”

A better alternative than co-personal representatives is to ask your attorney or perhaps your lifelong best friend (hopefully a trustworthy one — remember the key characteristics) to be your personal representative.

If you own your own business, or are one of the handful of owners (along with several partners of a closely held business), you need to pay special attention to whom you designate as your personal representative. Your personal representative may have to keep your business going. But if that person has no experience in your business, or doesn’t have the time to devote to your business, a significant portion of your estate’s value may go down the drain if your business collapses. Therefore, if you own a small business, you need to either select a personal representative who can represent your interests and keep your business going, or make other business continuity arrangements separate from the usual personal representative responsibilities.

Paying your personal representative

Now that your personal representative has done all this work, what does he or she get? You really can’t personally say, “Thanks for a job well done,” because you’re dead. Your personal representative is typically entitled to receive a personal representative fee. The fee varies among states, and the probate court approves the personal representative fee. Your personal representative receives payment at or near the end of the probate process.

Sorting through the List of Will Substitutes

You can hold property in a variety of will substitute types, including perhaps the two most important:

Joint tenancy
Living trusts

The following sections discuss each of those in detail. Additionally, you should try to have at least a passing familiarity with some other will substitutes, including

Tenancy by the entirety
Payable on death accounts (PODs)
IRAs, life insurance annuities, and other assets paid to named beneficiaries

Will substitutes predetermine who gets your property upon your death by one of two ways:

Right of survivorship
Beneficiary designation

Joint tenancy, tenancy by the entirety, and payable on death accounts use right of survivorship, whereas the other will substitute types use beneficiary designations.

Figuring out joint tenancy

Joint tenancy means that you and others have an equal and undivided ownership of some property. Basically, each joint tenant has the same right to use whatever property the joint tenancy agreement applies to. Joint tenants must own an equal percentage of the property. If two people hold interest in property as joint tenants, each owns one-half of the property; if three people hold interest, then each owns one-third; four people, each owns one-fourth, and so on.

The distinguishing characteristic of joint tenancy as a will substitute is the right of survivorship. In fact, joint tenancy is usually referred to as joint tenancy with right of survivorship, sometimes abbreviated JTWROS. The key feature of joint tenancy is that when you die, the other co-owner (or co-owners) receives your share of the property by right of survivorship. Whether you have a will or not is immaterial to the property transfer. If you have a will, the property transfers outside of your will. If you don’t have a will, the property transfers outside of intestate succession laws. The surviving joint tenant(s) receive(s) the property.

Family members often create joint tenancy to automatically leave property to the surviving joint tenant family member. However, as discussed later, joint tenancy has some significant disadvantages, so work with your attorney to figure out whether joint tenancy, or perhaps some other form of a will substitute (such as living trust) best suits your needs.

For example, Tom and Meghan own a house and hold title to the property as joint tenants with right of survivorship. At Tom’s death, Meghan automatically receives Tom’s share of the house because of the right of survivorship feature as joint tenants.

Now, suppose Tom, Meghan, and Avery — three people now instead of two — own the house as joint tenants with right of survivorship, meaning that each of them owns one-third of the house. Again, Tom dies. In this case, Tom’s share of the house is split equally between Meghan and Avery, who now each have a one-half interest in the house as joint tenants with right of survivorship. Later, upon one of their deaths, the surviving joint tenant will own the house.

In most states, during his or her lifetime a joint tenant can sever the joint tenancy without the consent or notification to the other joint tenants. The joint tenant who severs the joint tenancy then owns the property as a tenant in common with the other former joint tenant. But if more than one joint tenant remain, they still own their share of the property as joint tenants between themselves.

What? An example clarifies the preceding confusing scenario. Suppose Tom, Meghan, and Avery still own the house as joint tenants from the previous example. But Tom decides to deed (basically, to give) his interest to Sandra, thereby breaking his joint tenancy with the other co-owners. Now, the property is owned as follows: Sandra owns a one-third interest as a tenant in common, and Meghan and Avery own two-thirds interest as joint tenants between themselves.

Remember, Meghan and Avery still own the property as joint tenants so they have retained the right of survivorship with each other for their portion of the property. If Avery dies, Meghan receives Avery’s share of the property by right of survivorship and would then own two-thirds of the property as a tenant in common with Sandra.

Later, if Sandra dies before Meghan, her share of the property goes to her heirs or beneficiaries and not to Meghan as the other co-owner, because at that point, Sandra and Meghan own the property together as tenants in common. No right of survivorship feature exists because long ago, Tom (the original one-third owner who had deeded his interest to Sandra) broke his side of the joint tenancy relationship. Likewise, because Meghan no longer has a co-joint-tenant, her interest also passes to her heirs or beneficiaries at her death and not automatically to Sandra.

Advantages of joint tenancy

Why should you consider joint tenancy specifically as a will substitute? As an alternative to probate, joint tenancy provides you with several advantages:

Cost savings: The formation and eventual termination of joint tenancy is inexpensive. Unlike other forms of will substitutes, such as a living trust that an attorney should at least review and ideally prepare, you may save money by not necessarily needing to use an attorney to create a joint tenancy. (However, as with all other aspects of your estate planning, you need to work with your attorney as you plan your strategy and figure out what techniques best apply to you.)
Clear title transfer: Because joint tenancy is based on right of survivorship, joint tenancy allows for a clear transfer of title to the surviving joint tenant. No questions exist about the intent of who is to receive the property upon the death of one of the joint tenants. (To be certain that no question about intent exists, some states require that the wording “as tenants with rights of survivorship and not as tenants in common” be added.)
Creditors claim reductions: One of the main steps in the probate process is the payment of valid creditors’ claims. Before any of your beneficiaries can receive property transfers after you die, your personal representative must first pay any valid creditors’ claims. If your estate doesn’t have enough cash or cash equivalents to satisfy the creditors’ claims, your estate may be forced to sell property to pay the claims. However, because property held as joint tenants isn’t part of the probate process, creditors don’t have ready access to property held as joint tenants. Thus the amount of creditors’ claims may be reduced.

If the court can prove that you transferred title of property to joint tenants to hide from creditors, your creditors may still make a claim against part of your joint tenancy property.
Convenient and fast: You can easily create and ultimately dissolve ownership as you craft and later refine your estate plan. Furthermore, by not having to deal with complex legal documents — wills, trusts, and living trusts — you can use joint tenancy without worrying about the legality and hassles of the wording in these documents. Just a few simple words added to the property title and you’re done. In estate planning, you can’t get any faster than that! Beware, though: Even though you can dissolve the joint tenancy after it’s created, you can’t turn back the clock to the way things were before you created the joint tenancy without the permission of the other joint tenant or tenants.
Private: If you value your privacy, even after you’ve died, joint tenancy offers you a better alternative than probate, where your will and estate become part of the public record. Note, however, if your state has an inheritance or estate tax, you may be required to file a tax return and pay a tax on the decedent’s share of the jointly owned property. Because the tax return is usually a matter of public record, your wishes for privacy will be defeated.

Work out the tax scenarios with your accountant as part of your overall estate planning before you put joint tenancy wording on any property titles.

Disadvantages of joint tenancy

So far, so good with joint tenancy. The concept seems straightforward and the advantages sound pretty good. So why hold property any other way? Well, you know the old saying: If it sounds too good to be true, it must be an estate-planning concept. Holding property as joint tenants has significant limitations and disadvantages that you need to be aware of, including

Forced disposition: The surviving joint tenant(s) receive(s) your share of the property. Period. You can’t decide to leave a portion of that property to your joint tenant and another portion to someone else; the law forces you to leave your share to your joint tenant. So depending on the property in question and what you want done with that property after you die, joint tenancy may not be the right estate-planning tactic.
Lack of control in property transfer: The right of survivorship feature may not control the final transfer of property under joint tenancy. The death of the next-to-last joint tenant leaves the property to the surviving joint tenant as sole property; no right of survivorship exists when you own something by yourself. So unless other arrangements are made (even creating a brand new joint tenancy with other people), the property may ultimately become a part of the sole surviving joint tenant’s estate.
Undesirable property transfers: After the next-to-last joint tenant has died, the surviving joint tenant can dispose of the property in any way he or she wants, even if the disposal is contrary to the intentions of any other joint tenants who have died earlier. In effect, if you’re involved in a joint tenancy, you have to let go of any desires you have for the ultimate disposal of the property beyond the other joint tenants.

For example, suppose Kathy and Greg, who aren’t married and have no children, own a house as joint tenants. They discuss their intentions to leave the house upon their deaths to their favorite local charity. But after Kathy dies, Greg owns the house as the surviving joint tenant and can direct the property transfer to anyone he chooses at his death. Suppose Greg changes his mind and decides that instead of the charity, his sister — who didn’t get along with Kathy — gets the house at his death. So Greg’s sister receives the house and Kathy’s intentions for the property are out the window. (If the property was named in a will or held in a trust, they may have set up a chain of property transfers. The will could state that the survivor had use of the house while he or she was alive and upon his or her death, the charity is guaranteed to receive the house. In effect, choosing joint tenancy prevented Kathy from achieving her ultimate objective for the property.)
Exposure to other joint tenant’s creditors: Joint tenancy may protect property from your creditors’ claims after you die, but what about protection from creditors’ claims against your joint tenant? For example, if your joint tenant loses a court battle and has a large judgment against him, the property you hold as joint tenants can potentially be subject to the judgment resulting in a forced sale of the property.
Numerous tax disadvantages: Perhaps the biggest disadvantage of joint tenancy is in the area of taxes. A tax disadvantage? Didn’t you just read that a potential income tax savings from joint tenancy by the surviving joint tenant in a lower tax bracket may occur? Well, yes, but taxes are funny: In estate planning, what often saves you money in one tax area increases your taxes (sometimes significantly) in another tax area. In this case, the savings in income tax may be more than offset by the increase in estate tax.

For example, if you’re the surviving joint tenant from a property that you once held with two others as joint tenants, this property may inadvertently cause a payment of a larger estate tax. Furthermore, if your estate is large enough to be in a federal estate tax bracket, joint ownership and particularly a joint tenancy (or a tenancy by the entirety between husband and wife, as discussed later in this chapter) may preclude the ability to save or reduce federal estate taxes. For now, think of joint tenancy as having potential tax disadvantages when compared with wills or other will substitutes, such as living trusts.

Setting up a living trust

Book 5, Chapter 4 examines trusts in-depth, but here we look at the popular living trust as a will substitute form. A living trust is created while you’re alive (thus, the word living), unlike a testamentary trust, which is created at your death through your will. (Technically, a testamentary trust is similar to a will because it provides for property transfers at your death.)

You place certain property called trust principal into a living trust. (You may also see the word corpus referring to the property used to fund the trust, which often makes people nervous, considering how similar that word sounds to corpse — makes sense because both corpus and corpse come from the same root meaning “body.”)

When you create a revocable living trust, you can be in charge of your own living trust. When you die, the revocable living trust becomes irrevocable (meaning you can’t “undo” the trust — more on that in Book 5, Chapter 4) — and the trust principal (again, the property that you have placed into the trust) then passes to your beneficiaries without having to go through probate.

By making a trust revocable, you can dissolve the trust at any time up until death or until the trust document makes the trust irrevocable (such as in the event of your incapacity).

Roles for everyone!

The best way to examine a living trust is to look at the parties and roles involved. Living trusts involve the following roles (note that one person can play more than one role, as explained later in this chapter):

Trustor (or settlor)
Trustee
Successor trustee
Income beneficiaries (or current beneficiaries)
Remainderman (a “special class” of beneficiary)
Designated person managing minor beneficiaries

Don’t panic at the legal jargon. In a typical trust, the trustor (or settlor) creates the trust, and the trustee has the legal interest in managing the trust for the income beneficiaries who will have beneficial interest or right to use the trust property. After the beneficiaries receive their portion of trust, the remainderman is the trust beneficiary who receives the remainder or what is left over.

Book 5, Chapter 1 discusses two main types of property interest: legal, the right to manage property, and beneficial, or the right to benefit from the property. Trustees have the legal interest to transfer and manage property in the trust while beneficiaries have the right to use the property.

The successor trustee is the person you name to become trustee when you die (or become incapacitated) if you’re currently the named trustee. Think of your successor trustee as the personal representative of your trust. Look for a successor trustee who has the same attributes recommended for a personal representative earlier in this chapter. Typically, people name a spouse, child, or trusted friend as successor trustees.

You need to appoint someone (usually referred to as a guardian or a custodian) to manage the property of minor beneficiaries — those beneficiaries who aren’t of legal age.

The paperwork — ugh!

The actual living trust document varies just as wills do. (Work with your attorney to make sure you get all the necessary information correctly on paper.) The variations may include

Designating the trustor and the initial trustee
Defining trust property
Naming a successor trustee
Defining ways to revoke or amend the trust
Administering trust by trustee during trustor’s lifetime
Administering trust by the successor trustee after trustor’s death or incapacity
Defining trustee’s power
Restricting beneficiary assignments (spendthrift clause)

The trust sets forth in detail how the trustor must handle the trust after you’ve died.

Advantages of living trusts

So why the frenzy over living trusts? Living trusts are a convenient way to avoid additional probates if you have real property like a house, vacation home, or income-producing investment property located in more than one state.

Real property must be probated in the state where the property is located. More than likely, your entire probate process will be slowed down because of the need to administer more than one probate and the increases in fees and costs.

Some states consider real property held in a living trust to be intangible personal property, enabling your estate to avoid ancillary probate. If you have real property in more than one state, check to see how your state views real property held in a trust.

Privacy (as compared with probate) is another advantage of a living trust. As with other will substitute forms, your trust is a private agreement — a contract between the trustee and trustor. However, some county recorder offices require the filing of trusts as part of the public record.

To retain the privacy of trusts, your attorney can draft a separate document called a memorandum of trust, which identifies the most basic information of the trust. Therefore, your trust usually doesn’t become public record as your will does in probate.

However, if your state has an inheritance tax, the trust’s details may be required to be filed with the state through an inheritance tax return or other document. You may need to include the amount of trust principal and the identification of beneficiaries or remainderman.

The real attraction of living trusts stems from the advantages offered beyond the typical will substitute form advantages. Living trusts offer unique advantages:

Better planning
Better protection from probate
Better prediction of the future
Ability to name alternate beneficiaries
Ability to name guardianships

In preparing a trust, you place property into the trust (called funding the trust), and that property is thereafter known as your trust principal. By thinking through what property to include in your trust principal, you examine what property you have.

Unlike joint tenancy, where ultimately the last surviving joint tenant holds the property that can become part of the probate estate, living trusts provide you with better assurance of avoiding probate. In the earlier example, if Tom and Meghan own a house as joint tenants and Tom dies, Meghan, as the surviving joint tenant, now owns the house individually, making the house part of her probate property.

But instead of joint tenancy, suppose Tom and Meghan use a living trust to hold title as co-trustors and co-trustees to the house for both of their lifetimes. If Tom dies, Meghan still owns the house in trust, and the house is not part of the probate estate. Upon Meghan’s death, the house passes from the trust to the designated beneficiaries without being subjected to probate.

And what does predicting the future have to do with living trusts? Plenty, sort of. A living trust provides you with a peek into your estate’s future and how it will be handled. If you establish a trust as the trustor and name someone other than yourself as the trustee to manage your trust, you can preview how he or she handles the management of the trust property and determine if adjustments in your estate need to be made. No need for guesswork on how he or she will perform when you’re dead, when you can’t make any changes (for obvious reasons). You can preview the future now.

If your trust is set up to make distributions while you’re alive, you have the opportunity to see how both your trustee and beneficiaries may handle the trust principal distributions, affording you the opportunity to make adjustments if needed.

A living trust also allows you to name alternate beneficiaries if something happens to your primary beneficiary. You can’t name an alternate with other will substitute forms like joint tenancy or, as discussed later, payable on death accounts.

A living trust can also be set up to provide for you in case you become incapacitated and unable to care for your own affairs. This advantage is part of the reason living trusts are touted for the elderly. In such a case, you can avoid the necessity of a court-appointed guardian or conservator, or at least assist those persons in carrying out their duties.

Another method of avoiding guardianship or conservatorship is by the popular durable power of attorney, usually in addition to a living will.

Disadvantages of living trusts

Keep this adage in mind when you’re planning your estate: No good will substitute goes unpunished. Disadvantages exist no matter what road you choose, even with living trusts. These disadvantages include

Funding
Ongoing maintenance
Longer creditor claims period

The upfront funding of the living trust is a deterrent to many people. Remember, to hold title as joint tenancy, all you have to do is change the title to property with the appropriate wording. It’s not so simple with living trusts.

Living trusts require you to execute a trust document. But beyond the paperwork, the next step in the process is the trust’s actual funding. You as trustor must transfer your property’s title to the trust. So what’s the problem? Every time you acquire property — from stocks to real estate — you must transfer title of the property into the trust. For active investors, transferring your property’s title to the trust can become a hassle. (Then think about other property, such as cars, furniture, collectibles, and so on, which can be even more of a hassle!)

If you forget to put property in your trust, the property is treated as if it was never part of the trust and is handled through probate if you have a will, or intestate succession laws if you don’t have a will. For example, if you’re the beneficiary of someone’s life insurance or if you receive property that was formerly held as part of a joint tenancy — and you forget to take care of this property for living trust purposes — then that property isn’t part of the living trust.

Trusts require monitoring to make sure that everything is proceeding in accordance with the terms of the trust. Don’t just sign a trust document and put it away. The only way to achieve the advantage of previewing the future is to monitor the trust on an ongoing basis, which takes time and may not be for everyone.

Another living trust disadvantage is the potentially longer period for creditors’ claims. Why? In some states, trusts don’t protect property from being subject to creditors’ claims. Consequently, trustees may delay distributions to beneficiaries and remainderman until they’re certain all claims have been paid. Remember, no probate for trust principal exists, so consequently no probate process exists for the controlled processing of creditors’ claims.

If a trustee doesn’t perform certain required duties after the trustor’s death, he or she can have substantial personal liability. This reason is why trustees often delay property transfers until they’re certain all creditors have been paid.

Focusing on the costs of living trusts

You may have noticed that the costs of living trusts haven’t been mentioned as either an advantage or disadvantage. Why? Because the costs to set up a living trust can vary greatly. As with your will, you can prepare a basic living trust with preprinted legal forms or, alternatively, with an attorney.

Accordingly, the costs can range from a few dollars if you go the do-it-yourself route to more than $1,500 for each living trust that an attorney prepares. Because a living trust is considered a contract between the trustor and trustee, you shouldn’t mess around with a contract that may contain glitches. A living trust requires careful preparation and thinking. So just like with your will, if you decide to try to create a living trust on your own (which, again, we don’t recommend), at least have an attorney review it before execution.

Interestingly, the promotion and marketing of living trusts as part of estate planning has been anything but subtle. Some financial advisers hype living trusts especially to older citizens — giving sales pitches on how living trusts are the solution to all the world’s ills, and bombarding them with offers of expensive how-to seminars, workshops, and books on living trusts. Before exploring any of these options, make sure you understand what is being offered and what it will cost you. Although these preparations are touted as cost-saving, you’ll probably find it less expensive to work one on one with an attorney on your living trust instead of buying an expensive, boilerplate sales pitch.

Identifying Some Less Common but Worthy Will Substitutes

Beyond joint tenancy and revocable living trusts, you have some other options for will substitutes available. Although not as common as the first two methods, the ones discussed here still provide you with the opportunity to use will substitutes in your estate planning.

Tenancy by the entirety — the spouse’s option

Tenancy by the entirety — also called interests by the entirety — is related to joint tenancy. Similar to joint tenancy, the property’s co-owners have a right of survivorship feature that enables property to automatically transfer at the death of a co-owner to the surviving co-owner. Different states have different rules for tenancy by the entirety, so make sure your attorney advises you as you consider this type of will substitute.

There is one distinguishing characteristic of this form of will substitute: Only spouses can use it. Unlike joint tenancy, which can have any number of unrelated parties, a husband and wife are the only persons eligible to hold property as tenancy by the entirety. The surviving spouse becomes the sole property owner.

Tenancy by the entirety follows general guidelines for marital life. Always tell your spouse what you’re doing. Accordingly, one spouse can’t transfer his or her interest in the property without the consent of or notification to the other spouse. (Remember, a joint tenant can transfer his or her share to another person without the consent or notification of the other joint tenants.)

Some states don’t allow property to be held as tenancy by the entirety. Specifically, tenancy by the entirety isn’t recognized in most community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), and even some common law states don’t allow it. Where tenancy by the entirety is available, a divorce changes property ownership from tenancy by the entirety to tenants in common. If you decide to explore using this will substitute form, check with an attorney to see if your state recognizes it.

Joint tenancy bank accounts

A joint tenancy bank account is a form of joint tenancy where two or more people take title to property — in this case, a bank account — with the surviving joint tenant receiving the proceeds from the account.

With joint tenancy, a joint tenant can sever the joint tenancy without the consent or notification to the other joint tenants. Here, the bank account joint tenant can sever the relationship by withdrawing funds from the joint account.

Gift taxes may come into play with joint tenancy bank accounts. Before you use this will substitute form, talk to your accountant and attorney to understand the implications. Don’t just ask the person at the bank who helps you fill out the forms.

Savings bonds

Yes, the same savings bonds that, along with green stamps, Hula-Hoops, and first-run shows of Leave it to Beaver, are often thought of as icons of days long ago. But savings bonds actually are a form of will substitute.

Savings bonds can be issued in two ways:

Alternative payee
Beneficiary payee

When you use the alternative payee option on a savings bond, payment of the bond can go to either co-owner of the bond (you or your alternative) similar to the joint tenancy provision of right of survivorship. After one of you dies, the surviving payee is the bond’s sole owner.

By using the other option — a beneficiary payee — you and another person have a similar relationship to a beneficiary named in your will. If the savings bond is yours, the beneficiary you have named receives the bond’s proceeds after your death.

If you have a stash of savings bonds locked away in your safe deposit box or some other safekeeping place, double-check to see what the estate-planning impact is of each individual bond when you’re inventorying the contents of and determining your estate’s value (see Book 5, Chapter 2).

PODs — payable on death accounts

They may sound rather morbid, but payable on death accounts (PODs) are a simple will substitute form that keeps personal property out of probate. You fill out a form at your financial institutions and designate your account beneficiary. After your death, your beneficiary provides the financial institution with a copy of the death certificate and proof of identity and then collects what is in the account. (Doesn’t get much simpler than that.)

Because your beneficiary receives the account proceeds at your death, periodically review the accounts for two reasons. First, verify that the named beneficiary is still who you want to receive the proceeds. Remember you can change your mind at any time while you’re alive. Second, some accounts may also grow faster than others, causing disproportionate proceeds to different beneficiaries that you may not be aware of without reviewing the account.

Your beneficiary doesn’t have beneficial interest in the account and thus can’t withdraw money from the account until your death. You have the flexibility to change your mind and name a different beneficiary, or you can even decide that you want to use the funds in the account. Easy come, easy go!

Deeds

For real property like your house, a deed is a weapon in your will substitutes arsenal available for your use.

A deed is the legal evidence of real estate ownership. Deeds, like wills, have several legal requirements to be valid, including being in writing with an accurate legal description of the property.

You can write wording into a deed to create a will substitute for your real property. Work with your attorney to make sure the wording in your deed accurately reflects the type of will substitute you want to set up.

If the deed is used only as a property transfer mechanism at the grantor’s death, the deed may not be considered a valid will substitute form and is subject to probate. Check with your attorney about state laws to find out what requirements are needed for a deed to be considered a will substitute form.

IRAs and your other retirement accounts

Even if you’re just beginning your estate-planning efforts, you may already have will substitutes as part of your estate and not even know it.

Most of your retirement savings accounts — your IRA, 401(k) or 403(b) plan, your Roth IRA, and other retirement-oriented investments — are forms of will substitutes. For example, for a 401(k), the spouse is automatically listed as the beneficiary.