Wills, Revocable Trusts and “Pass by Contract” Assets: What’s the difference?
Find out how estate transfer documents can work together to create a comprehensive plan.
June 30, 2020 | by Phillip Buchanan
Thoughtful estate planning is important if we want to provide for the people and causes we truly care about in life. The process includes terms – such as will, revocable (“living”) trust, and Beneficiary Designation/Payable on Death/Transfer on Death forms – that may not be familiar to everyone. In this article, we hope to help you gain a better understanding of how these estate transfer documents can work together.
Most individuals’ estate plans will typically leave assets to loved ones (heirs) or charities under one or more of the following:
Will – Some or all of your assets can pass to your loved ones or charities under the terms of your will – a written document that specifies your wishes for the division of your assets after your death. Under the terms of your will, an executor – a person, bank, or trust company you select, will administer your estate assets. A will also covers matters unrelated to the transfer of assets, such as guardianship for your minor children, care for a parent, etc. Unless specifically made irrevocable, your will is revocable and you can change it up until the time of your death. Assets that are transferred under your will must go through the probate process of the state where you were a resident at the time of your death and, based on the value of your estate, may be subject to state probate and inheritance fees or taxes, plus state and federal estate taxes. The state probate law generally requires that assets that pass under a person’s will be held by the estate for at least one year under the theory that unknown heirs, creditors, or other claimants need time to discover your death and make their claims. Your executor will work with the local probate court to substantiate the validity of any such claims. You should also talk to your legal advisor about any “elective share” rights of your spouse. Many states provide a minimum percentage of the probate estate that must go to your spouse if he/she elects after your death.
There are many types of trusts that are used for different purposes and each is administered by a person or entity (e.g. a person, bank, or trust company you select) known as a trustee. The most common type of trust utilized for estate planning is a revocable trust – also known as a living or inter vivos trust. As the name implies, it is revocable during your lifetime and you have complete control of the assets until your death. You typically transfer assets into the revocable trust while you are alive and these assets pass to your heirs upon your death. This type of trust serves as a will substitute for some of your assets and is commonly used to hold brokerage accounts, real estate (especially if owned in several states), and high-value assets or collectibles. One benefit is that assets held in a revocable trust bypass the state’s probate process and legally become the assets of the heir/beneficiary immediately upon your death rather than being held up for a year or more in probate, though it may take a little time for the trustee to transfer the assets to your heir. Please note that if you have a small estate or the bulk of your assets can pass “by contract,” you may not need a revocable trust – because the costs incurred in creating and maintaining it may exceed any cost savings.
Many commonly owned assets can simply pass “by contract” and avoid probate fees and other administration costs. This includes assets such as life insurance policies, an IRA or other type of retirement plan, bank or brokerage accounts, or commercial annuities, which you can pass to your loved ones under a Beneficiary Designation Form (BDF) or a Payable on Death (POD), Transfer on Death (TOD) or Totten trust form. These forms are available from the company that administers the account or plan. If available, passing assets by contract may be the most cost-effective and efficient way to make an immediate transfer of assets at death – either to loved ones or to charity.
You should consider these three estate asset transfer techniques as complementary to each other and part of the “big picture” for your overall estate plan. Please note that your heirs/beneficiaries typically have nine (9) months to disclaim inherited assets if they wish to do so. These assets can then pass to a contingent or secondary beneficiary (e.g. “I disclaim Mom’s $100,000 bequest so it can pass to my daughter, Sarah (or a charity) as named in the will, trust, BDF, etc.”). You may consider this option as part of a disclaimer planning strategy when you create your estate plan, which basically allows your heirs to take a “wait and see” approach until the (unknown) date of your death. Then, at the time of your passing, your heirs decide if they need the assets or would prefer that the assets go to their children, charity, or other named beneficiaries. Please note that these contingent/secondary beneficiaries should be named in the will, trust or BDF/POD/TOD form so the disclaimed assets will pass directly to them rather than revert to your probate estate.
During the estate planning process, an individual should also consider other assets, such as an anticipated inheritance from relatives, deferred compensation, and anything else of value that may come to them during their lifetime or be payable to their estate after their death.
Please note that assets that pass by will, revocable trust, or by contract are still part of the person’s taxable estate if he or she had any control over these assets at the time of their death. In other words, all of the assets you own at your death will still be counted for purposes of any state and federal estate/inheritance taxes due. The federal exemption in 2020 is $11.58 million per person and $23.16 million per couple.
There is no “one size fits all” solution for estate planning, and this article only covers a few of the most common asset transfer techniques a person may consider. A modest investment of time and effort on your part (“sweat equity”) may significantly (1) decrease the stress your loved ones would otherwise endure if you do not have a thoughtful and efficient estate plan in place, and (2) increase the dollar amount and impact of estate gifts to your loved ones and your favorite charities.
For more information about these or other gift planning options, please contact our team of experts in Duke’s Office of Gift Planning.