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, according to Caring.com, who don’t currently have a will or trust, your family will likely head to probate court. Even estates with wills 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 to a will or the courts.
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What Is a Transfer on Death (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 TOD accounts. If you own part of a TOD property, only your ownership share will transfer.
A TOD account will prevent you from compiling additional debt through probate related to executor and attorney’s fees. However, it can’t erase your estate’s debt. Creditors can still go after assets in a TOD account. 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 Account Beneficiaries
TOD account holders can name multiple beneficiaries and divide assets any way they like. If your TOD investment account is set up to be split evenly between your children, each will receive an even part when you die.
However, the beneficiaries have no access or rights to a TOD account while its owner is alive. You can also change those beneficiaries at any time, so long as the TOD account holder is 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.
A TOD account also 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 you have a 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 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.
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.
If you have a surviving spouse, investment and bank accounts pass to them before a 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 the 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.
Pros and Cons of TOD Accounts
When planning for the future, ensuring a smooth and efficient transfer of assets to loved ones is a top priority. Certain financial tools provide a way to simplify this process, offering a direct and hassle-free means of passing down wealth. These options can help beneficiaries avoid unnecessary delays, legal complexities, and additional expenses, making them an appealing choice for many individuals looking to streamline their estate plans. However, while these tools offer clear advantages, they also come with potential drawbacks that should be carefully considered before making a decision.
Pros of Transfer on Death Accounts
- Avoids Probate: Assets transfer directly to the named beneficiary without going through the lengthy and costly probate process.
- Simple & Cost-Effective: Setting up a TOD designation is usually free and only requires a simple form from the financial institution.
- Immediate Access for Beneficiaries: The designated beneficiary can access the funds quickly, without waiting for court approval.
- Maintains Owner Contro: The account owner retains full control during their lifetime, including the ability to change or revoke the TOD designation.
- Privacy Benefits: Unlike probate, which is a public process, TOD accounts remain private.
- No Tax Consequences at Setup: Naming a beneficiary does not trigger taxes; the transfer only occurs upon death.
Cons of Transfer on Death Accounts
- No Protection Against Creditors: If the account holder has outstanding debts, creditors may still claim assets from the TOD account before they reach the beneficiary.
- Potential Family Disputes: If a TOD designation contradicts a will or family expectations, disputes may arise.
- Inflexibility for Estate Planning: TOD accounts do not allow complex distribution rules, such as staggered payments or trust-like provisions.
- Not Effective for Minors: If the beneficiary is a minor, a court-appointed guardian may be required to manage the funds until the child reaches adulthood.
- Multiple Beneficiary Challenges: Some financial institutions may not allow multiple or contingent beneficiaries, making estate planning more difficult.
- Overriding Will Intentions: Assets in a TOD account pass outside of the will, which may unintentionally disrupt an estate plan.
Choosing the right approach for asset distribution depends on individual priorities, financial goals, and family dynamics. While some methods offer simplicity and efficiency, they may not always align with complex estate planning needs or long-term financial strategies. Weighing the benefits against potential risks is essential to making an informed decision that protects both the estate and its intended beneficiaries.
Bottom Line
Estate planning can be difficult and something that people don’t like to think about. When your family is grieving, a lack of 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
- A financial advisor can help you properly plan out your estate. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can 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 types of wills, and you may find that one addresses your needs better than a TOD. For reference, here are some things to know about making a will.
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