Attorney-prepared estate planning documents aren't worth the paper they're written on if your client's assets are not titled properly.
Most clients have no understanding of the way that the titling of an asset directs its flow in their estate. They may have received a cover letter from their attorney detailing the steps needed to re-title their assets to complete their estate planning, but often it gets filed away with the documents and never addressed. When you do your review of a client's estate plan, make sure that the investment assets you manage are titled properly and find out about their other assets, especially real estate. Don't rely on your client's memory--have them actually check the deed.
The Most Common Misperceptions
Many clients think that all their assets will be distributed at their death according to the terms of their will or trust. It is important for them to understand that many assets--maybe everything they own--could pass outside their estate, depending on the way the assets are titled. It's not uncommon for couples to have wills that set up bypass trusts, and at the death of the first spouse, they discover there are no assets to fund the trust because they are all jointly owned and bypass the estate completely.
Problems such as these result from failing to understand the importance of titling.
Assets that are owned "joint with right of survivorship" or "tenants by the entireties" will automatically pass directly to the survivor. Also, any asset with a beneficiary designation will go directly to the named beneficiary. The most common examples are IRAs, other retirement accounts, life insurance, and annuities.
The three primary types of ownership are fee simple, tenancy in common, and joint tenancy with right of survivorship:
Fee simple is ownership by one individual, who owns all the property and can give it away, sell it, or leave it on death. The property is subject to probate at death and will flow into the client's estate to be distributed according to the terms of the will. Fee simple property can also be titled in the name of an individual's living trust to avoid probate.
Tenancy in common means that there is more than one owner, and each owns a share of the asset. Each owner has less control of the whole property than an individual who owns a fee simple interest, but does have the right to give away, sell, or leave his or her share at death.
Joint tenancy with right of survivorship is commonly used by married couples, but can be used by two or more individuals as long as they each have an equal interest and they acquire that interest at the same time. Each co-owner owns all of the property with the others. They can sell or transfer their interest during life, but cannot bequeath the interest at death. This type of ownership does not allow the deceased's share of the property to pass into his estate; rather, it transfers automatically to the other owner(s).
Another type of joint tenancy is tenancy by the entirety, which is available only to married couples and allows them to own property as a single legal entity. This means that they must act together when making any decisions about the property. For this reason, it is commonly used as an asset protection technique, as the creditors of one spouse cannot attach and sell the interest of the debtor spouse. This type of property passes automatically to the surviving spouse at the death of the first spouse.
The Unintended Consequences of Asset Titling
We just finished reviewing the estate plan of a couple who married several years ago. Since they had both been widowed, they had sufficient assets in their own names and agreed not to leave their estates to each other.
After marrying, the couple decided to purchase a home together for $1,500,000, assuming they would each own one-half. They each contributed $400,000 for half of the down payment, and they have split the payments on the mortgage of $700,000. When the house settled, the attorney (who was just handling the real estate transaction) recorded the deed as joint tenants with right of survivorship--which we discovered only when we asked to see the actual deed. These clients were dismayed to discover that they will have to pay to have the deed corrected to tenants in common to allow for each of their interests in the house to be available for distribution to their respective heirs. They are now changing the titling of the property to make sure it passes as they intended.
Other Titling Methods That Bypass the Estate
A titling technique that is becoming more widely used for bank and investment accounts is "transfer on death" (TOD) or "payable on death" (POD), where the account owner names a beneficiary. We have seen this used by individuals who want to make sure that someone, usually a child, has access to liquid assets immediately upon their death. But what are the consequences?
Let's say Mom has $60,000 in cash in the bank and a house worth $150,000. Her intention, as stated in her will, is to divide her estate equally among her three children, leaving $70,000 to each. However, she names her oldest son as the beneficiary of her bank account using the TOD language, since he will be the executor of her estate. At her death, he receives all the cash, and the house is still split three ways. He walks away with $110,000 and his two siblings receive only $50,000, one-third of the house. This is not at all what Mom intended.
The Importance of Planning
When we review clients' estate plans, we start by listing all the assets by how they are titled, and then create a flow chart showing where they will end up at their death. This is especially important for a married couple. Frequently, we find that all the assets move directly to the surviving spouse, which negates the benefits of the estate planning documents.
Another couple, Mike and Jane, have substantial wealth in real estate and a very comprehensive estate plan, with revocable living trusts and an irrevocable family trust. The real estate is owned in several limited liability companies. For asset protection purposes, the real estate attorney titled all the LLC interests in Mike and Jane's names as "TBE (tenants by the entireties) with common law rights of survivorship." As a result, all of the wealth generated by the real estate will transfer to the surviving spouse at the death of the first spouse, thus circumventing the goals and design of their estate plan and leaving their trusts unfunded. Clearly, the clients did not understand their estate plan enough to inform the real estate attorney of their intentions.
Failing to identify titling issues can result in a failed estate plan and unhappy beneficiaries. No advisor wants that to happen on our watch.