Funding Revocable Trusts – Part II – How Do Assets Pass Upon Death?

In funding Revocable Trusts Part I, we discussed the importance of avoiding probate. We also pointed out Revocable Trusts are the tool of choice rather than Wills because of probate avoidance.

However, a basic question prior to directing assets into your Revocable Trust upon death, is how do assets pass upon death? First, if an asset has a beneficiary designation, the beneficiary designation directs the asset upon death. Examples of beneficiary designation assets are life insurance, annuities, and retirement assets (e.g., IRA, 401(k), government pension plans). Now, as state law has evolved, bank accounts and brokerage accounts may pass by beneficiary designations by payable on death or transfer on death designations.

If an asset does not have a beneficiary designation, then assets pass by title. Assets can be titled in your name alone, in which case the asset needs to be transferred into your Revocable Trust to avoid probate. If an asset has a joint owner with a survivorship right, then it passes directly to the surviving joint owner. Most married couples have assets titled “tenants by the entirety” that means the asset passes directly to the surviving spouse and also is protected during the married couples’ lifetimes from a lawsuit against only one spouse. (Virginia recognizes tenants by the entirety but not all states do.)

For purposes of avoiding probate, assets need to be coordinated among those that have beneficiary designations, those that have sole or joint ownership, and those that need to pass through the Revocable Trust. Coordinating beneficiary designations and title ownership is important for more than just probate avoidance.

Consider this example: Mr. Decedent provides in his Will that current wife Number 2 shall receive all his assets upon his death. Further, if Wife Number 2 predeceases him, the assets shall pass equally to his two children from his prior marriage. His primary assets are his $1 million insurance policy which still lists his first wife as the beneficiary; his IRA, which names his two children as beneficiaries; and his residence, where the Deed names only his oldest child as a joint owner with right of survivorship.

Mr. Decedent does not realize that assets that pass by beneficiary designation (e.g., IRA’s, 401(k)’s, life insurance), or by title if there is a joint owner with right of survivorship (e.g., house, bank or brokerage account), supersede any provisions contained in a Will (or Revocable Trust for that matter). Therefore, under the facts above, absent state law to the contrary, wife Number 1 receives the life insurance, the children receive the IRA, and the house passes to his oldest child. There are not many assets left to go to current wife Number 2. Further, even if current wife predeceases Mr. Decedent, the oldest child still receives the residence – it is not divided evenly among the children.

In this example, although probate may be avoided because the bulk of the assets have beneficiary designations or joint ownership, the result is an estate planning disaster for Mr. Decedent and his second wife.

The moral of the story is you cannot do estate planning without focusing on how your assets are titled and the asset beneficiary designations. Those titling and beneficiary designation decisions are as important to the planning process as provisions in your Revocable Trust and pour over Will.