What is transfer on death (TOD) for estate planning?

Planning for the inevitable is never easy, but a smooth transition of your belongings can ease the burden on your loved ones after you pass away. One of the strategies that can help you achieve this is setting up a transfer on death (TOD) order for your financial accounts. 

The transfer-on-death designation allows your assets to bypass the probate process and pass directly to your named beneficiaries upon your death. A TOD account can allow beneficiaries to focus on healing rather than on the complex task of managing your estate. 

Here’s what you need to know about transfer-on-death accounts and how they work. 

What is a transfer-on-death account?

A transfer-on-death account is an arrangement that allows the assets held within a brokerage account or bank account to pass directly to a named beneficiary upon the account holder’s death, thus bypassing probate. Probate is a legal process that can be time-consuming and costly, involving the settlement of your estate and distribution of your assets under court supervision. 

By avoiding probate, a TOD account ensures a quicker and more efficient transfer of assets to your loved ones, meaning your money can go to those heirs you want to have it.

How does a TOD account work?

A TOD account works allows the account owner to designate one or more beneficiaries who will receive cash or investments upon the owner’s death. During the owner’s lifetime, the beneficiaries have no access to or control over the account. 

Once the owner dies, the assets in the account are transferred to the beneficiaries, when they provide proof of death, such as a death certificate, to the financial institution where the account is held. The institution then typically opens a new account in the beneficiary’s name and transfers the assets into it. 

It’s important to note that the rules and regulations for TOD accounts may vary by state, so check with the financial institution to see how the process is handled in your area. 

What types of assets can have a TOD designation?

TOD designations are found primarily on investment accounts, but other assets can also have a TOD designation. For example, real estate can have the designation via a transfer-on-death deed, and vehicles can have a TOD designation through a transfer-on-death title. 

In contrast, banks usually offer a payable on death (POD) form to transfer money from a bank account, but the process is similar to a TOD designation. 

How does a TOD account benefit estate planning?

TOD accounts offer several benefits for estate planning, particularly in their flexibility. 

• Simplicity: TOD accounts provide simplicity by enabling the automatic transfer of assets to beneficiaries upon the account holder’s death, bypassing the potentially long and costly probate process. 
• Full control of assets: TOD accounts give you full control over your assets while you’re alive, with the flexibility to change beneficiaries at any time. You can also name multiple beneficiaries and specify the division of assets according to your wishes. 
• Avoidance of probate costs: A TOD account can help heirs avoid some probate-related expenses. However, it’s important to note that it doesn’t protect against an estate’s debts. Beneficiaries may still be subject to inheritance taxes and capital gains taxes.

What is the difference between a TOD account and a will?

A TOD account and a will serve different purposes in estate planning. A TOD account allows for the direct transfer of assets to beneficiaries upon the account holder’s death. On the other hand, a will is a legal document that outlines your wishes regarding the distribution of assets and the care of any minor children after your death. 

Unlike a TOD account, a will goes through probate and its instructions are carried out by an executor. It’s important to note that if there’s a discrepancy between your will and your TOD account, the TOD account typically takes precedence. 

So, if you name your brother as the beneficiary of your brokerage account in your will but your sister is listed as the beneficiary on the account’s TOD form with the brokerage company, your sister will inherit the account, not your brother. Experts recommend that TOD accounts should not conflict with your will, so that your assets go to the person you really want to have them. 

How to set up a TOD account for estate planning

Setting up a TOD account is relatively easy, and it’s usually as simple as filling out a TOD designation form provided by your broker or financial institution. This form will ask you to name the beneficiaries and specify the proportions of assets each will receive upon your death. 

If you’re naming a minor as a beneficiary, be aware that a court-appointed custodian may be needed to manage the assets until the child reaches adulthood. It’s essential to periodically review and update your beneficiaries as necessary, and to make sure your TOD account is part of your comprehensive estate plan. If you don’t verify your beneficiaries periodically, your assets may not go to whom you now intend, and heirs may have little recourse.

After you’ve passed away, your beneficiary should contact the firm and inform them of your death. The brokerage firm will then request documents to verify your death, such as a death certificate or a current court letter of appointment. Once the necessary paperwork is submitted and verified, the firm usually establishes a new account for the beneficiary, transferring your securities and funds into it.

What are the tax implications of a TOD account?

Despite the convenience of avoiding probate, a TOD account does not inherently provide tax benefits or protections against estate or inheritance taxes.

Upon your death, estate taxes may apply if the total value of your estate exceeds the federal exemption threshold, which is $13.61 million in 2024. Most people won’t come anywhere close to this level. However, a handful of states do impose inheritance taxes, which are paid by beneficiaries, though these exemption amounts are also generously high. 

For capital gains, beneficiaries get a step-up in basis to the fair market value of the assets at the date of your death, which can provide significant tax benefits if the assets have appreciated in value. 

What are the potential downsides of a TOD account?

A TOD account can help avoid the costs of probate but it doesn’t eliminate all potential issues. Some of the key downsides of a TOD account include:

• Does not eliminate the need to pay off debts: While TOD accounts offer convenience and simplicity, one risk is that your estate might not have sufficient funds to pay off debts, potentially requiring your estate’s executor to liquidate property to satisfy the debt. 
• May interfere with an inheritor’s government benefits: If a beneficiary receives government benefits, a sudden and hefty inheritance could jeopardize those benefits.
• May conflict with a will: TOD accounts can conflict with your will, but TOD designation supersedes a will. Confusion over your wishes may create strife among your heirs.
• Does not offer help if incapacitated: A TOD provision offers no assistance in the event of your incapacity to act, unlike a power of attorney or trust, as beneficiaries can only access the funds after your death. This setup can prove problematic if you have expenses but loved ones cannot access your assets to pay for those expenses.  

Bottom line

A TOD account can be a useful tool in estate planning, offering a straightforward way to pass assets directly to beneficiaries upon your death. However, it’s important to consult with an estate planning attorney or financial advisor to ensure that a TOD account aligns with your overall strategy and goals. Remember, while TOD accounts can help avoid probate, they aren’t a substitute for a comprehensive estate plan.