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What is a transfer-on-death account?

Transfer on death (TOD) accounts can keep your estate planning intact while keeping your beneficiaries out of court. If you’re among the 57% of adults who don’t currently have a will or trust, your family is likely headed to probate court. Even estates with wills will likely need to go through probate, which can burden your loved ones and create hostility between family members. A TOD account can avoid a legal mess by moving your assets without leaving them in your will.

What Is a TOD Account?

A transfer on death (TOD) account automatically transfers its assets to a named beneficiary when the holder dies  For example, if you have a savings account with $100,000 in it and name your son as its beneficiary, that account would transfer to him upon your death.

As Fidelity Investments notes, a TOD is “a provision of a brokerage account that allows the account’s assets to pass directly to an intended beneficiary; the equivalent of a beneficiary designation.”  Though laws governing estate planning vary by state, many bank accounts, investment accounts and even deeds are considered TOD accounts. If you own part of a TOD property, only your ownership share will transfer.

TOD Account Beneficiaries

What is a transfer-on-death account?

TOD account holders can name multiple beneficiaries and divide assets any way they like. If you’ve opened a TOD investment account to be split evenly between your two children, each will receive half of its holdings when you die.

However, the beneficiaries have no access or rights to a TOD account while its owner is alive. Those beneficiaries can also be changed at any time, so long as the TOD account holder is deemed mentally competent. Similar to when you leave assets in a will, transfer on death doesn’t establish any rights until after you die. While you live, the named beneficiaries can’t access or control the accounts.

TOD Accounts vs. Wills

The most important benefit of a TOD account is simplicity.

Estate planning can help minimize the legal mess left after you die. Without it, , the probate system can take over the distribution of your assets. It can also name an executor of your estate and pay off your remaining debts with your assets. It then distributes whatever is left according to your will, but only if you have one. If you don’t, your assets are distributed evenly by the probate court to whatever living relatives the executor can find. and

Meanwhile, when a person with a TOD account dies, the executor sends a copy of the death certificate to an agent at the account’s bank or brokerage. That account is then re-registered in the beneficiary’s name.

TOD Account Supersedes a Will

A TOD account skips the probate process and takes precedence over a will. If you will all of your money and property to your children, but have a TOD account naming your brother the beneficiary, he will receive what’s in the account and your children will get everything else.

If property in your will and have a TOD deed on that property, the TOD order may take precedence. The law varies by state, but banks and brokerages in many states will honor a TOD as soon as you die. If you have any doubts about a TOD contradicting your will, you may want to double-check the terms or consult an advisor

TOD Accounts and Death

A TOD account will prevent you from compiling additional debt through probate related executor and attorney’s fees, but they can’t erase your estate’s debt. Creditors can still go after assets in a TOD account, while tax collectors can impose federal estate tax than $11.4 million. TOD accounts are also subject to inheritance tax and capital gains tax, as well as taxes on withdrawals from pre-tax investments including IRAs and 401(k) plans.

TOD Accounts and Spouses

What is a transfer-on-death account?

If you have a surviving spouse, investment and bank accounts will pass to them before going to a TOD account beneficiary. Depending on state law, a beneficiary may receive the assets of a TOD account only after a spouse’s death, if at all. Massachusetts and Colorado are among states with strong spousal inheritance laws, so you may want to look into local law yourself or have an advisor do it for you while composing your estate plan.

Pitfalls of TOD Accounts

While a TOD account can be divided among several beneficiaries, that doesn’t mean it has to be divided equally. You may want to consult with beneficiaries and advisors to avoid any potential conflicts. Also, a TOD account with someone under 18 as a beneficiary could be an issue, as minors can’t control investment accounts. If you haven’t designated a guardian or set up a trust (and named a trustee), that may be a conversation worth considering.

Bottom Line

When your family is grieving, complex estate planning can further complicate their lives. If you have someone in your family who you feel can responsibly manage the investments and property you leave behind, a transfer on death (TOD) account may be an ideal way of transferring portions of your estate while avoiding probate.

Estate Planning Tips

  • As you begin the estate-planning process, a financial advisor can be a big help in organizing your finances and accounts. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.
  • If you still have questions about wills and TODs, you may want to consider the strengths and limitations of wills. There are multiple wills, and you may find that one addresses your needs better than either another will or a TOD. For reference, here are some things to know about making a will.

Note: This article discusses legal matters touching on estate planning, tax planning and other areas of the law. Nothing in this article should be considered legal advice. For all specific questions, speak with a lawyer.

Photo credit: ©iStock.com/Pgiam, ©iStock.com/Mladen Zivkovic, ©iStock.com/Duncan_Andison

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