Investing for the rest of us – How property passes at death

Death, taxes and teenage text messages: these are the certainties of life. The tax code is too complicated for anyone to understand, and why teens can text all day but never write a thank you note is an unsolved mystery.

Death, on the other hand, is somewhat simpler. One day you are reading the newspaper and the next day you are in it. Let’s take a look at what happens to your property once everyone knows where to send the flowers.

First of all, and to the surprise of many people, most of your property probably won’t end up in probate court. Only what happens will go through the process. If you don’t have a will, don’t worry, the state has one for you. Of course, the state has never met you and does not know how you want things to be distributed, but whose fault is it? Dying without a will is called intestate. You don’t want to die intestate. Go see an estate planning attorney and get cured.

Now that we’ve sorted that out, here’s how the property goes.

Life Insurance and Life Annuities

Death benefits are paid to designated beneficiaries. Unless you name your estate as the beneficiary, death benefits will escape probate. It is generally not a good idea to name your estate as the beneficiary. One reason is that the assets in your estate are available to creditors. The benefits also take longer to reach your heirs. An heir has not yet been born who wants your money sooner rather than later.

If you are exposed to estate taxes, you may want to consider an irrevocable life insurance trust (ILIT). An ILIT keeps the proceeds of death out of your taxable estate.

Life insurance companies used to send a check directly to the beneficiary. Today they are more likely to send a checkbook that can be accessed by the beneficiary. Life insurance companies claim that this is more convenient for the beneficiary. Call me crazy, but I think they do it to hold the money a little longer. Most beneficiaries already have a checking account. Why would they want another?

Retirement Plans

Deferred Retirement Plans, including Individual Retirement Accounts, go through the beneficiary. The same rules apply to the surviving spouse that exist for annuities. Obviously it helps to have a surviving spouse. The people who wrote this tax code were probably married.

A Roth IRA also passes through beneficiary, but has no income tax ramifications for the beneficiary, even if the beneficiary is not the surviving spouse. The people who wrote this part of the tax code were probably divorced, but they had many children.

If taxes are due when received by a beneficiary, the taxes can be spread over several years using different techniques, including a “rollover beneficiary IRA.” Go see a financial planner to see what works for you.

Jointly owned property

Many properties, such as real estate, bank accounts, and brokerage accounts, are jointly owned. The most common form of joint ownership is “Joint Owners with Rights of Survivorship (JTWROS).” The surviving owner automatically obtains the asset upon the death of another owner.

JTWROS should not be confused with another type of joint ownership called “tenancy in common.” Tenancy in common divides property into real shares and when an owner dies, he can leave the property by will to whomever he wants. Take a country house on the coast jointly owned by two married brothers. If one dies, he can leave his share to his wife and children. Then they can continue enjoying their vacation by the sea. Naturally, as this is passed from generation to generation, it creates a veritable family rat’s nest, but if you can’t fight family over who gets the best weeks of summer, who can you fight?

Property in your own name

Now we come to the property that passes by will. If you only own something that does not pass in the manner described above, it becomes part of your probate estate. For example, if you own a savings account in your name only, it goes through your will. Your will names an executor, a thankless but necessary job. It is up to the executor to take an inventory of his estate and eventually distribute it to his heirs.

Many people are establishing and funding “living trusts.” These trusts are established during your lifetime and are funded with assets that would otherwise be probated. Since most people are their own trustees, control of assets is not an issue. Upon the death of the individual, the assets come under the control of a new trustee. Since the assets are already in trust, they escape the probate process. The assets are still exposed to estate taxes because you controlled them during your lifetime.

That’s the basics. Consult a financial planner and estate planning attorney to work out the details. This is an area that is not fertile ground for do-it-yourselfers, and death does not allow mulligans.

The opinions expressed in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investments may be appropriate for you, please consult your financial advisor before investing. All performance referenced is historical and is not a guarantee of future results. All indices are unmanaged and cannot be traded directly.