One of the most important estate planning concepts is the significance of asset titling. Perfectly drafted legal documents will not accomplish your goals if your assets are not titled appropriately. It is vital to understand the various methods of asset ownership and the consequences that flow from each.
Three basic ways to transfer assets at death:
- Through your probate estate (sole ownership and tenancy in common);
- By operation of law (joint tenancy ownership); or
- By contract (trusts and beneficiary designations).
Assets passing through your probate estate
Only property titled in a decedent’s sole name or in “tenancy in common” (TIC) will pass through a decedent’s probate estate. Sole name property is simple ownership in one person’s name without a joint owner and without a living designated beneficiary.
Tenancy in common is co-ownership of property (often real estate) with another person or persons where there is no joint tenancy with right of survivorship specified. This is generally the default method of co-ownership when “joint tenants with rights of survivorship” is not specifically provided for. The result is that each co-owner owns an undivided fractional in interest in the property and when one co-owner dies the decedent’s fractional interest will pass through the decedent’s probate estate.
Assets passing by operation of law
1. Joint Tenancy (with rights of survivorship) — Joint tenancy has long been a popular form of ownership, particularly between spouses. Its principal advantage is that the asset automatically passes to the surviving joint tenant(s) by operation of law, thereby bypassing probate (upon the death of the first joint tenant). However, while joint tenancy is often used as part of a well-organized estate plan, it is usually not sufficient in itself. The following is a non-exhaustive list of some of the drawbacks and limitations of joint tenancy that should be considered:
- Probate is merely delayed not avoided. While joint tenancy successfully avoids probate upon the death of the first joint tenant, it does not avoid probate upon the death of the survivor. While you may plan to later add on a new joint tenant, this plan is not effective in a simultaneous death situation or when further planning is not accomplished.
- Transfer into Joint Tenancy may be a taxable gift. Depending on the joint tenant, the nature of the property and state law, a transfer into joint tenancy may constitute a taxable gift. Even worse, the transfer may be a taxable gift, but not effective for removing that portion of the property from your estate. For example, assume father adds son to the title of his residence while continuing to live in that residence. Upon transfer, father has made a taxable gift of one-half of the value of the residence. However, father has a “retained interest” with regard to the entire residence. As a result, gift tax exemption is used but the entire residence is still taxable in father’s estate upon his death.
- The property is generally reachable by creditors of ALL joint tenants, regardless of who originally owned or funded the asset. As a result, if you add your child(ren) on the title to your property, in one fell swoop you are subjecting that property to a creditor or ex-spouse of that child.
- The joint tenant can take all the money and run. This may not be a problem, but are you sure?
- For spousal joint tenancies, there is no “step up in basis” on the entire property, only on the decedent’s portion. This could result in unnecessary capital gains when the surviving joint tenant eventually sells the property.
- Joint tenancies produce no estate tax savings.
- Non-spousal joint tenancies may subject your estate to unnecessary and costly litigation. While the general rule is that joint tenancies pass automatically to the surviving joint tenant(s), there is an exception made for “convenience accounts” when an estate can show by clear and convincing evidence that the decedent intended the joint asset to pass in their estate and not to the surviving joint tenant. This is the source of a tremendous amount of costly probate litigation within families.
2. Tenancy-by-the-Entirety (“TBE”) — TBE is a concurrent estate, similar to joint tenancy, which can be established only by and between a husband and a wife for a primary personal residence. The primary difference (and advantage) that a TBE has over joint tenancy is that creditors of an individual spouse cannot reach real estate held in a TBE to satisfy a claim of only one, but not both, of the spouses. Another factor to consider is that, unlike a joint tenancy, a TBE cannot be unilaterally severed by either joint owner.
Assets passing by contract
1. Beneficiary Designation — Another means of transferring property on death that is available for certain types of assets is a beneficiary designation. This is generally used for retirement benefits (IRA, 401(k), 403(b), pension, profit sharing), life insurance, and annuities. Read here for more information on beneficiary designations. A “Pay-on-Death” (POD) account is a method of owning a bank account in your own name, while bypassing your probate estate by naming a person(s) to receive the proceeds of your account on your death. Some brokerage institutions also allow a similar “transfer on death” (TOD) designation for securities. While this type of account can avoid probate, if used properly, it is an inferior device to a living trust in terms of flexibility, avoiding guardianships, and creditor protection for beneficiaries. As of January 2012, Illinois permits “transfers on death instruments” (TODI) for the transfer of residential real estate upon death.
2. Trusts — Assets properly titled in a living trust pass privately under the terms of the trust. Such assets do not pass under the terms of your will and are not subject to the probate process. To be effective, the actual legal title on the property or account must be titled in the name of the trustee of the trust. Illinois also recognizes “land trusts” for ownership of real property. A land trust is usually established with a bank as the trustee and the beneficiary having a power of direction over the property. Land trusts may only hold real property.