*updated September 2020 in light of the SECURE Act

What exactly is “probate” and why would you want to avoid it? Probate is the legal process whereby a last will & testament is determined by the Court to be authentic and valid. The Court will then “admit” the will to probate and issue “letters testamentary” to the Executor so that the Executor can carry out the decedent’s intentions in accordance with the last will and testament. That usually involves paying all funeral bills, administrative expenses, debts, settling all claims, paying any specific bequests and paying out the balance to the named beneficiary or beneficiaries.

Avoiding probate can be accomplished by creating a trust to hold your assets during your lifetime and then distributing the assets at your death in the same manner and sequence as an Executor would if your assets passed through probate. Typically, this would be accomplished by creating a revocable trust and transferring all non-retirement assets to the trust during your lifetime, thereby avoiding probate at your death.

Retirement assets like 403B’s, IRA’s and non-qualified annuities are not transferred to revocable trusts as they have their own rules and should transfer after death by virtue of a beneficiary designation. These are considered “non-probate” assets. Retirement assets should not be subject to probate so long as a designation of beneficiary is made. If not, the assets defaults to the estate and must go through probate. The take away here is that you should make sure that you have named primary and contingent beneficiaries on your retirement assets. If you name a trust for an individual, you must discuss that with a competent professional that can advise you if the trust can accept retirement assets without causing adverse income tax consequences – especially in light of the SECURE Act.

However, avoiding probate can be a disaster if it is not done as part of a comprehensive plan, even for the smallest estate. For example, consider this case:

Decedent dies with two bank accounts, each naming her grandchildren on the account. This is called a Totten Trust account. Those accounts each have $25,000. She has a small IRA of $50,000 that also names the grandchildren as beneficiaries. She owns no real estate.

Sounds simple, right?

The problem is that the grandchildren are not eighteen years of age. The parents cannot collect the money for the children because they are not Guardians of the property for their minor children. Before the money can be collected, the parents must commence a proceeding in Surrogates Court to be appointed Guardians of the property for each child. After time, money and expenses, and assuming the parents are appointed, they can collect the money as Guardian and open a bank account for each child, to be turned over to them at age 18. The IRA would have to be liquidated, it could not remain an IRA and the income taxes will have to be paid on the distribution. I do not know of a worse scenario for most 18 year old children to inherit $50,000- when they may be applying for college and seeking financial aid, or worse, when deciding not to go to college and are free to squander it however they want.

If the grandparent had created an estate plan that created trusts for the benefit of the grandchild, then the trusts could have been named as the beneficiaries of the accounts and the entire debacle could have been avoided. Instead of a guardianship proceeding the grandparent could have chosen a Trustee and dictated when the children would inherit. Since the children are grandchildren, the IRA would have to be paid out over a ten year period.

The concern is that individuals are encouraged to avoid probate by merely naming beneficiaries but with no understanding of the consequences. The point is that while there are cases where naming individuals as beneficiaries is entirely appropriate–to avoid probate–there are also times that naming a trust as beneficiary is the less costly option, and neither should be done without a plan in mind.

At a time when the largest growing segment of the population is over 90, it does not take long to figure out that the likely beneficiaries will be in their 60’s, 70’s or older when they inherit an asset. Thought must be given to protecting those beneficiaries from creditors, divorcing spouses (one out of two marriages end in divorce), and the catastrophic costs of long term care. Whether the estate is large or small, most decedents want to protect their heirs. A well drafted beneficiary trust can accomplish that goal.