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Dec 1994

Avoiding probate. (includes related article)

by O'Sullivan, Timothy P.

    Abstract- Avoiding probate in estate planning allows the distribution of the property of testators to the person they wish to have it at a time they so desire without incurring a substantial amount of income, estate and inheritance taxes as well as attorney's fees and other administrative costs. There are three common estate-planning tools that can be used to avoid probate in the distribution of testators' property at death: joint tenancy with rights of survivorship, beneficiary designations and revocable trusts. Joint tenancy is applicable to all property types except retirement plans and individual retirement accounts (IRAs) while beneficiary designations can be used for life insurance policies, retirement plans and individual retirement accounts. Revocable trusts can be utilized, unlike the first two devices, can be used with all types of property.

Probate costs both time and money. Here's a look at three ways to avoid such costs.

A good estate plan should distribute a testator's property to whom the testator wishes, when the testator wishes, with a minimum amount of income, estate, and inheritance taxes and the lowest possible attorneys' fees and other administrative costs. Avoiding probate can be an important component in achieving these goals.

Why Does Property Go Through Probate?

When an individual dies owning property titled in his or her name, normally that property must go through a judicial process. The probate department of the district court enters a decree stating who succeeds to the ownership of the property. Without probate, title to the property would remain in the name of the individual who has died. Title would be clouded and the property could not be sold or transferred because a potential purchaser would have no way of determining who can legally execute a title transfer such as a deed. The judicial decree resolves this uncertainty.

If a person dies without a will, that is, intestate, title to the property will pass under state intestacy laws to "heirs at law," i.e., normally one-half to a surviving spouse and the remainder (or all of the property if there is no surviving spouse) equally to the children, with a predeceased child's share going to such predeceased child's children in equal shares. If a married person dies without a will and has no children, normally all property goes to his or her spouse. The person appointed to administer the estate of someone who dies without a will is called an administrator.

If a person dies leaving a valid will, that is, dies testate, title to the property will be distributed to the beneficiaries specified under the provisions of the will. As additional benefits to leaving a will, a will can name the person who is to administer the estate (the executor), name a guardian for minor children, ease the burden and costs of administration of the estate by waiving court approval of certain actions (such as the sale of real property), waive the posting of a bond by the executor, create trusts for beneficiaries if desired, and include estate, inheritance, and income tax savings provisions.

Under the laws of most states, a surviving spouse has a right to a certain percentage (typically one-half; in New York it is the greater of $50,000 or one-third of the net estate) of the decedent's estate and certain additional allowances, such as the right to live in the homestead and spousal allowances, and cannot be limited to a lesser amount under the terms of a will unless he or she has consented in writing to the will or has waived those rights under a premarital agreement. Everyone else, including children, normally has no right to inherit and thus may be completely disinherited trader the provisions of a will.

What Devices Avoid Probate?

There are several estate planning devices that avoid probate in distributing property at death. These devices principally are joint tenancy with rights of survivorship, beneficiary designations, and revocable trusts. These devices avoid the necessity for probate proceedings only. They do not, simply because they avoid probate, avoid estate and inheritance taxes.

Joint Tenancy

Joint tenancy ownership can be used on all types of property except retirement plans and IRA's (which are governed by beneficiary designations discussed later). Joint tenancy avoids probate because under the law of joint tenancy, when a joint tenant dies, as of the moment of death the deceased joint tenant has no remaining ownership in the property and the surviving joint tenant(s) automatically succeeds to full ownership of the property. All the surviving joint tenant needs to do to establish ownership is file of record (if real estate) or show to third parties (with respect to personal property), a death certificate of the deceased joint tenant. Since this succession is automatic and a probate court determination is unnecessary, joint tenancy property is not normally governed by the terms of the deceased's will or revocable trust.

Using joint tenancy to avoid probate can be quite hazardous. A person named as a joint tenant becomes a co-owner, and the act of naming that person is normally a gift, unless the tenancy is revocable, such as normally exists with joint tenancy bank, savings and loan, and credit union accounts. Although there are no gift tax consequences between spouses, non-spousal joint tenancies that are not revocable (as is normally the case), will constitute a taxable gift to the extent the non-spousal joint tenant's undivided share of the joint tenancy property constitutes a gift in excess of the $10,000 annual exclusion. Due to such co-ownership, placing property in joint tenancy between non-spouses also causes a significant loss of control over property, as the property becomes subject to the claims of co-owners, their creditors (such as would occur in a garnishment or attachment), and spouses (such as in a divorce).

The rights of co-owners are a particular problem with joint tenancy bank, savings and loan, and credit union accounts. According to the joint tenancy signature card, normally any joint tenant can withdraw the entire account. Although this is unlikely during lifetime while the creator of the account has capacity, it might occur during incapacity or by one joint tenant acting alone as of the time of death, even if there are other joint multiple tenants on the same account. Consequently, if a person wishes to add a child or any other person on a financial institution account to pay bills, sign checks, etc. on his or her behalf, he or she may wish instead to add such person as an additional signature on the account. This makes such person an agent, but normally avoids giving the child (and/or his or her creditors and spouse) any ownership rights in the account. Avoiding probate with a person such as a child is normally better accomplished in financial institution accounts through payable-on-death designations (if available under local law) discussed later. Like additional signatures, they do not give any present ownership rights in the account.

With respect to non-spousal joint tenancy interests (e.g., between a parent and child) in the personal residence, income tax exclusions otherwise available upon sale (the two year "rollover" into a new residence trader IRC Sec. 1034 and the one-time lifetime exclusion of $125,000 of gain if over age 55 under IRC Sec. 121) can be jeopardized. These exclusions would not be available with interests of joint tenants who do not meet the age requirement or reside in the residence. Non- spousal joint tenancies also generally do not provide for coordination of affairs at death, such as for payment of taxes and administration expenses. Further, they can distort the plan of distribution of property at death. Joint tenant children may predecease a parent (thus in effect disinheriting not only themselves, but also their children), or if they survive, such children will receive joint tenancy property in addition to whatever shares they receive from a decedent's estate, possibly causing unequal or unintended distributions. Moreover, transferring title to property held in joint tenancy with children will require their signatures on subsequent dispositions. If real estate is involved, often under state law, their spouses' signatures may also be required. This could be a significant problem if family harmony becomes discordant or a child becomes incapacitated. Finally, placing property in joint tenancy with children means they will own the entire property outright at the surviving parent's death, not in trust. For a number of reasons, it is often more advisable to place property in trust for children.

Consequently, joint tenancy is normally not desirable as a probate avoidance device between non-spouses. Between a parent and children, the degree of undesirability becomes greater with the number of children, as the foregoing risks increase proportionately. With respect to spousal joint tenancies, prior to titling property in joint tenancy, each spouse first must be comfortable with the other's control of the property. For example, the surviving spouse may not be a good asset manager, may have a mental infirmity, may be subject to significant creditor claims (being involved in a risky occupation), likely to remarry without entering a premarital agreement, or it could be a second marriage with children by prior marriages. Secondly, the total estate of both spouses should not likely exceed the federal estate tax exemption equivalent so as to create significant estate tax upon the surviving spouse's death. Third, the potential spend down of all assets by the surviving spouse prior to qualifying for Medicaid benefits must not be a significant concern. Even if all three of these concerns are not significant, it is important to keep in mind that 1) spousal joint tenancy will not avoid probate if both spouses die in a common accident (its there would be no surviving joint tenant/spouse); 2) spousal joint tenancy does not avoid probate on the surviving spouse's death (unless the surviving spouse either puts the property in joint tenancy with others, with the above noted possible problems, or sets up a revocable trust after the predeceased spouse's death); and 3) spousal joint tenancy property will only receive a one- half "step-up" in income tax basis on appreciated capital gain property to fair market value at date of death. This contrasts with the full "step-up" it would have received had the property been owned outright by the predeceased spouse or in the predeceased spouse's revocable living trust. This last factor can be significant in estates having a significant amount of appreciated capital gain assets, such as farm land, rental properties, and stock portfolios.

Example. Assume a couple owns a rental property with a tax basis (initial cost plus capital improvements less tax depreciation) of $20,000 and a fair market value of $100,000. Assume further the husband is managing the property and his wife would sell it if she survived him (which occurs approximately 60% of the time if husband and wife are the same age). Finally, assume the husband does predecease his wife. If the property is held in joint tenancy, under IRC Sec. 1014, only one-half of the property, i.e., the husband's share, receives a "step-up" in tax basis at his death. Thus, his surviving spouse's tax basis in the property would be his "stepped up" value of $50,000 plus the old tax basis in her one-half, $10,000, for a new tax basis of $60,000. Should she then sell the property for $100,000, she would still have a $40,000 capital gain. Had the property been owned solely by her husband or in his revocable trust, the new tax basis at his death would have been $100,000, and there would have been no capital gain. Likewise, often it is best to divide joint tenancy appreciated stock portfolios so that both husbands and wives own them individually or in revocable trusts. In that way, the survivor may sell the predeceased spouse's stock portfolio and benefit from a full step-up in basis.

Even when joint tenancy is chosen between spouses, the couple should have a will to provide for administration and disposition of their joint estate upon the surviving spouse's death or upon a simultaneous death, as well as for guardians for any minor children.

Beneficiary Designations

Beneficiary designations under life insurance policies, retirement plans (e.g., pension, profit sharing, and 401(k)s), and IRA's avoid probate because they constitute contractual or trust obligations specifying the persons to whom proceeds should be paid. For example, under a life insurance policy, a policy owner contracts with the life insurance company to pay out a death benefit to a designated beneficiary or beneficiaries. There is no need for a probate court decree specifying who should receive the insurance proceeds because that has already been provided by contract.

Some states statutorily allow the designation of one or more "payable on death" beneficiaries on bank, savings and loan, and credit union accounts. Such "payable on death" designations normally can be changed by the account owner at any time, and alternate beneficiaries can be named in the event a beneficiary is deceased at the time of the owner's death. Financial institution accounts are titled assets. Barring joint tenancy or ownership by a revocable trust, without this specific statutory provision, these assets normally have to go through probate on the owner's death.

Federal law provides similarly for beneficiary designations on U.S. savings bonds.

With respect to securities (such as stocks and mutual funds), some states have enacted the Uniform Transfer on Death Security Registration Act. This Act allows individuals whose registration of a security shows sole ownership by one individual, or multiple ownership by two or more with right of survivorship, to obtain registration of the security in beneficiary form. This means registration of a security that identifies the present owner of the security and the intention to pass title to the security to the person upon the death of the owners. Registration of the security may be shown by the words "transfer on death" or the abbreviation "TOD" or by the words "pay on death" or the abbreviation "POD." The designation of a beneficiary does not affect the ownership of the security until the death of the owner. The owner retains the right to cancel or change the registration at any time. On the death of the sole owner, or the death of the last multiple owner, ownership of the security registered in beneficiary form passes to the named beneficiary on the security. Contingent beneficiaries may also be specified. If no beneficiary survives the death of all owners, the security belongs to the estate of the deceased sole owner or the last to die of all multiple owners.

Real estate and other types of property not discussed above normally cannot use beneficiary designating to avoid probate. If probate avoidance is desired, joint tenancy or revocable trusts should be considered.

It is important to keep in mind that property distributed at death pursuant to these probate avoidance devices normally will not be governed by the provisions of a will. Therefore, property passing to a surviving joint tenant or a beneficiary under a life insurance policy would normally be in addition to any share of probate property that person would receive under a will. The failure of a large segment of the population to understand this principle is perhaps the single most important factor in many estate plans going awry.

Revocable Trusts

The final probate avoidance device is a revocable trust. A revocable trust is a legal entity that can hold title to property (in the same manner as other legal entities, such as partnerships and corporations, except that title is in the name of the trustee). As such, it avoids probate by having title in the name of the trustee of the revocable trust and not the decedent at the time of death. At that time, the named trustee (or successor trustee) has authority to pay the decedent's bills and has a fiduciary responsibility to distribute the trust properly to beneficiaries as provided in the provisions of the trust. A revocable trust is the only device that can be used with all types of property and does not depend upon survival of specific persons to avoid probate.

Is a Will or Revocable Trust Best?

Revocable trusts (sometimes called "living trusts") have the following advantages over wills:

* Privacy. With revocable trusts, financial affairs and to whom property is given at death are private. Wills and inventories of probate estate are matters of public record.

* Cost Savings. Assets named in a revocable trust avoid the probate costs and additional attorney fees that would be incurred in a probate estate (although varying from state to state, accounting and attorney's fees and other administration costs can average perhaps three to four percent in a probate estate versus one to two percent in non-probate estates). This is particularly beneficial if real estate is located in a state other than the state of residence. Probate would otherwise normally be required in more than one state.

* Convenience. Revocable trusts serve as a conservatorship substitute in the event of incapacity (although use of durable powers of attorney usually can achieve much the same result).

* Coordination of Estate Plan. A revocable trust coordinates the entire estate plan and all assets through one instrument, thereby avoiding property going to beneficiaries in disproportionate amounts through joint tenancy or beneficiary designations.

* Continuity. Revocable trusts serve as an ongoing mechanism after death to pay bills, pay taxes, and manage and distribute assets without any delay (although delays solely attributable to the probate process are normally inconsequential in a well managed estate) or the court approval necessitated by probate proceedings.

* Stability. Revocable trusts normally do not need to be changed due to moving to another state.

* Security. Due to the lesser degree of formality surrounding their execution and the lack of an existing court proceeding in which to make an objection, revocable trusts are somewhat more difficult (and thus usually less likely) to be legally challenged after death.

The grantor (the one creating a revocable trust) retains complete control over the assets of the revocable trust during lifetime and can change its provisions at any time in the same manner as a will. Moreover, all income from trust assets would continue to be shown on the grantor's individual tax return (Form 1040) and no trust income tax return needs to be filed as long as the grantor is serving as a trustee. If at any time the grantor is not serving as a trustee, an information return would be filed showing the income as taxed to the grantor.

A revocable trust arrangement has some disadvantages.

* Greater Initial Cost and Effort. There is a greater initial cost and effort in drafting and titling assets (trust funding) in a revocable trust compared to a will. The trust-funding process does have a desirable side benefit, however, as it frequently uncovers title errors before they become a problem and at a time when they are easier to correct.

* Probate Avoidance Not Assured. The grantor must be careful to place all subsequently acquired titled assets in the trust or probate may still be necessary.

* Possible Income Tax Detriments. There are some normally minor income tax detriments that may be incurred during the one or two year period of trust administration following death that would not be present if a will were used for estate planning. RRA '93 raised the income tax rates on trust and estate income. In addition, a trust cannot elect a fiscal year, and there is a $100 versus a $600 income tax exemption.

Neither a will nor a revocable trust has any advantage over the other in saving estate, generation-skipping tax, or inheritance taxes. Further, property can be distributed to beneficiaries after death in the same manner under both types of documents. Accordingly, trusts for beneficiaries after death can be created under either instrument, and some states allow a guardian to be named for minor children under a revocable trust in the same manner as under a will.

If a revocable trust is desired, it is recommended that a "pour over" will also be executed, which would place any assets left out of the trust into the trust at the time of death. With proper supervision in retitling and the use of universal assignment documents, however, it is normally unlikely that property would go through probate.

Whether a will or revocable trust is chosen, consideration should be given as to who is to serve as executor of the will as well as to alternate executors. The same is true with respect to the initial trustee (if the grantor elects not to be his or her own trustee) and successor trustees under a revocable trust. A grantor may wish to have more than one named successor trustee or executor serving at a time, and such successor trustee and executor can be individual or corporate (e.g., bank trust departments). Normally, to avoid conflicts, it is advisable that the successor trustees and the executors be the same. If only a will is involved, not only will executors have to be identified, but also will trustees for any trusts created under the will ("testamentary trusts").

In spousal situations, revocable trusts are given strong preference when there are significant above-discussed detriments to joint tenancy ownership present, i.e., spousal control, federal estate tax liability upon the second death, adverse Medicaid consequences, or loss of a full "step-up" in income tax basis. Splitting ownership to avoid these problems generally means that unless revocable trusts are used (each spouse setting up a separate revocable trust), there will be probate on both spouses' deaths. However, if the only perceived detriment is probate upon the surviving spouse's death (which is normally perceived to be a greater detriment the older the couple), a single joint trust for both spouses should suffice. With single individuals, revocable trusts are useful as a probate avoidance device in the normal circumstance when it is inadvisable to place property in joint tenancy with a child or children. If an individual has no children, avoidance of additional probate costs upon a single individual's death or upon the death of a surviving spouse is usually not a high priority, as it normally benefits more distant relatives or charities who are named to take ownership at death.


Corporate fiduciaries (banks and trust companies), have many advantages over individuals as executors and trustees. They are more secure, are automatically bonded, can avoid conflicts of interest where children or other close relatives would otherwise serve as trustees, are excellent record keepers, provide continuity for long-term trusts, normally are more experienced so as to minimize mistakes (in investments, administration and tax decisions), and lessen the need to hire outside counsel. The disadvantages are that they may lack the personal touch, are subject to turnover in their trust officers, often have difficulty in managing active businesses and farms, and at least initially, may be unfamiliar with the family situation involved.

The fact that corporate fiduciaries are often termed conservative in investment strategy and administration may be an advantage or disadvantage, depending strictly on point of view. A given corporate fiduciary's total fees may be more or less than what an individual would charge, depending on the size of the estate, the corporate fiduciary's fee structure, the expertise of the individual trustee relative to such individual trustee's need to retain outside investment, tax and legal counsel, and the aggressiveness of the individual trustee in charging fees. Often, in order to maximize the benefits of both types of fiduciaries, clients will name individuals and corporate fiduciaries as co-executors and co-trustees. Each can even be given separate and distinct authority with respect to the estate or trust, e.g., the individual co-trustee determines distributions and the corporate co- trustee governs investments. This can, however, result in a higher total fiduciary fee than if either was selected to serve alone.

If an individual fiduciary is selected to serve alone, that individual should be mature and responsible, have no credit problems (to avoid the temptation to "borrow" from the estate or trust), not be dolorous or dilatory, and have sufficient time to adequately perform his or her duties. It is also desirable if such individual has business and investment experience. If a corporate fiduciary is selected to serve alone or as a co-fiduciary with an individual, its current fee structure should be reviewed and inquiries made as to its reputation.

Timothy P. O'Sullivan, Esq., is a partner in Fleeson, Gooing, Coulson & Kitch, LLC, Wichita, Kansas and an adjunct associate professor at Washburn University School of Law.

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