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The Not-Quite-Insolvent Estate

An insolvent estate is one that doesn't have enough assets to pay creditors in full. But what about the estate where all of the assets have specific beneficiary designations and yet there are bills to pay?

Helen Modly and Tommie Monez, 08/11/2011

The wills and trusts are in place, assets have been reregistered, and beneficiary designations have been updated. There are sufficient assets to cover outstanding bills and final expenses. There is a prepaid funeral that covers everything from buying the cemetery plot to the angels adorning the casket, and there was even a family meeting to discuss the final arrangements. Nothing has been left to chance. So what could go wrong? Plenty.

Estate planning is a complicated business and sometimes it's easy to mess up even the simplest of situations. Take a recent example from one of our clients. Her widowed stepmother had asked our client to be executor of her modest estate. It seemed simple enough. There were some savings accounts, one stock in a publicly traded company, and a small home that was paid off. The funeral was prepaid and there was no debt. But as it turned out, there was zero liquidity when the client's stepmother died.

It is not uncommon for liquidity problems to occur when there is no surviving spouse. At the first death, there are usually assets that are readily accessible to the survivor, plus ongoing Social Security and pension income. When a single client or surviving spouse dies, there can be serious cash-flow problems. 

The Transfer-on-Death Trap
Transfer on death, or TOD, is a way of designating beneficiaries to receive your assets upon your death without having to go through probate. Also referred to as pay on death, TOD is available for most bank accounts, money markets, and brokerage accounts. As an advisor, you might recommend to a client that they have a TOD on any accounts held outside of their living trust, naming their living trust as the beneficiary, so that at death, those accounts transfer directly into the trust without probate.

The TOD provisions can cause unanticipated problems, though, if not fully understood. For example, suppose your client chooses to name one of her children as beneficiary of an account using a TOD, thinking that the child will have money to pay bills after her death. The money in the account goes directly to the child, not divided equally among all her children, as her will stipulates. If only illiquid assets go into her estate, there could be a serious problem if the child takes the money and runs.

This is what happened to our client's stepmother. She originally had a trust account at a bank which was moved to a new relationship at a credit union that included certificates of deposit, a savings account, and a checking account. With the best of intentions she had opted for an individual account with designated beneficiaries instead of using her revocable trust registration. The pay-on -death designation even applied to the checking account. To make matters worse, the shares of stock also had a TOD designation. That left zero cash for the executor to use for bill paying.  

Other Liquidity Problems
The situation with the house was sticky, too. Rather than retaining the house as an asset of the estate, with the proceeds available to pay debts before being distributed to the beneficiaries, the estate documents stipulated that the house itself would be inherited by four individuals in equal shares. All parties would have a say in choosing a realtor, setting the selling price, and deciding on needed repairs and maintenance. The possibilities for conflict were endless. Not only did these decisions require consensus, there was no available cash to pay for ongoing upkeep of the house through the date of sale.

With the sale of the house potentially several months away, the expenses were adding up fast. The prepaid funeral ended up costing more than $1,000, the estate attorney and expenses associated with transferring property ownership came to more than $5,000, and the costs for cleaning out and maintaining the house continued to mount.

As a result of the liquidity issues, our client considered refusing to accept the executor position but as there was no contingent executor named, the only alternative would be having the court appoint a personal representative, which was also expensive.  

After much discussion, the beneficiaries of the house agreed to share expenses based on their ability to pay (yet another touchy subject). The executor volunteered to personally cover the expenses, providing the other beneficiaries agreed that all expenses would be reimbursed prior to division of the proceeds from the home sale. This was a formal document signed by all parties. The estate attorney also agreed to be paid at the real estate closing. This is a great outcome, as many families don't work this well together and many simply do not have the means to cover costs. Late charges, liens, and cancellation of basic services can result and ultimately diminish the value of the property. 

Periodic Estate Plan Review
Adding a periodic estate plan review to client meetings can head off problems that can creep in over time when clients add assets and accounts that are not registered properly. The transfer-on-death and pay-on-death designations for bank accounts are very tempting to choose, since then those assets will pass outside of probate. But like the case of our client, leaving real estate to be sold with no money to support it can create a difficult situation for the executor.

Clients who take the time and effort to create estate plans do so for their heirs. They will be appreciative of your proactive efforts to reduce the burden on their survivors, especially when those burdens can easily be planned away.

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