It’s hard to talk about death. It’s hard to prepare for death. It’s harder still when you are by yourself and can’t take advantage of the almost automatic transfer of assets to a spouse. As a single person, your assets unnaturally will flow upwards to your parents or sideways to your siblings. And after death, there will be taxes to consider.
“… in this world nothing can be said to be certain, except death and taxes.” — Benjamin Franklin
I wish to reduce the burden on my family in the event of my demise. While I can’t do much after my death, I can make sure that my assets are distributed swiftly and without complication, so the funds can be used to pay for my cremation and funeral expenses. The goal is to avoid probate, which can cost 3–7% of the total assets (to cover attorney and court fees), can take months to more than a year, and is an invasive process that makes the asset inventory public.
Warning: I am not an estate lawyer or tax accountant, so please treat the following with a big grain of salt.
POD and TOD
I am single. I have no children. I own no real estate. All my money is invested in stocks, mutual funds, bonds, or bank accounts. I need a quick, simple way to avoid probate upon my death. The solution is POD and TOD.
POD stands for “Pay On Death” (to a named beneficiary), which describes what the bank will do for savings and checking accounts. Some banks may instead refer to POD as ITF, “In Trust For”. TOD stands for “Transfer on Death” (to a named beneficiary), which describes what would happen to stocks, mutual funds, bonds, and money market accounts. Assets with designated PODs and TODs are excluded from probate.
The named beneficiary could be one person or more. You may also be able to name a secondary or contingent beneficiary should the primary beneficiary not be among the living at the time of your unfortunate, hopefully painless, demise.
I’ve decided to ensure that all my accounts have my mom and dad as equal 50% primary beneficiaries. Should one die, the other will get 100%. If I can only have one primary beneficiary, I will pick one or the other. On accounts where I can, I have my younger sister (my most generous-in-nature sibling) listed as the contingent beneficiary should I survive my parents’ deaths and neglect to update the beneficiary information. She can distribute the money however she wishes. Similar to how my parents can distribute the money to my siblings, whether fairly or unfairly. I’ll be dead so it won’t matter to me; not my problem.
Most large investment firms (like Vanguard and Charles Schwab) will allow you to update the TOD beneficiaries online. They also support adding one or more contingent beneficiaries. Unfortunately, not all banks allow you to manage POD beneficiaries online. And they may only allow one primary beneficiary and no contingent beneficiary.
Surprisingly, Ally Bank allows you to manage more than one POD beneficiary online; no contingent beneficiary supported though. Disappointingly, the huge Bank of America does not support any online access for POD and only allows one primary beneficiary. Instead, you must make an appointment with a banker at the physical “brick and mortar” branch location to add or update the POD beneficiary. The banker told me that the reason is security; they used to hand out the “Beneficiary Letter of Instruction” form but no longer do so.
For my few physical possessions (mainly my car), the total probate assets should be below the probate limit (varies by state; it’s $150,000 in CA), so probate is avoided. Probate assets would not include the stocks, mutual funds, bonds, and bank accounts covered by TODs and PODs. Physical assets should go to my parents by default. If that is not possible, then a will, stating which sibling will receive what, would expedite the process.
Some states allow TOD registration for vehicles. If I have an expensive vehicle (which might push me over the probate limit), I would definitely complete the vehicle TOD registration.
Alternatively, in states that disallow vehicle TOD, I could pre-fill out the “Notice of Transfer” form on the car’s “Certificate of Title”. I would use a pencil to fill out the form (in case I need to change it), so there is a little risk that an unscrupulous person could erase and fill in their name. Or use a pen if you don’t mind getting a replacement form should god forbid, the person named dies before you do.
Step-Up in Basis
Because my assets are way below the $11.4 million estate and gift tax exemption, taxation should not occur. My beneficiary should not have to pay any tax on stocks, mutual funds, bonds, and bank cash accounts.
Stocks, mutual funds, and bonds are subject to step-up in basis, which minimizes capital gains tax. For my beneficiary, the basis cost of these assets is adjusted to the price on the day of my death. For example, if I purchase a stock share at $5 and it is $50 on the day I die, when my beneficiary sells the share, the capital gains tax is calculated based upon the gain from $50, not from the $5. If the stock has appreciated greatly, step-up in basis results in a tremendous tax saving. (Step-up in basis also applies to real estate value.)
The complication to the above are traditional pre-tax IRAs and 401Ks. They are not subject to step-up in basis. Worse, only spouses can roll over a gifted IRA/401K into an existing IRA/401K. My parents and siblings can convert the gifted IRA into an inherited IRA (aka “Stretch IRA”), but would need to start taking distributions, according to the IRS RMD (required minimum distribution) schedule, regardless of their age. (A gifted 401K would be converted into an inherited 401K.) The early 10% withdrawal penalty (for those less than 59.5 years old) does not apply. Unfortunately, the distributions are taxed as regular income.
Alternatively, a non-spouse beneficiary could immediately cash out the pre-tax IRA/401K (lump sum distribution) if they are willing to accept the resulting huge income tax bill. Or if I am less than 70.5 years old at my death, my beneficiary could use a five-year method, where they must distribute all assets in the IRA/401K within five years. However, I recommend using an inherited IRA/401K with RMD to minimize the yearly income tax. (Though pre-tax 401Ks are treated the same as pre-tax IRAs, there might exist an alternative treatment based upon the company’s agreement with the 401K administrator.)
Rules for gifted Roth IRA and Roth 401K for a non-spouse beneficiary are similar, though the distributions are not taxable. You can take a lump sum distribution or convert to an inherited Roth IRA/401K with a RMD schedule.
For after-tax IRAs and after-tax 401Ks, I could not find an answer as to whether the step-up in basis applies; my guess would be no. Like the pre-tax IRA/401K, I am guessing that a non-spouse beneficiary would have to take a lump sum distribution or convert to an inherited after-tax IRA/401K with a RMD schedule. Most importantly, only the gain (minus basis, step-up or not) in the distributions would be taxable as income. Thankfully, I don’t have either account types. I don’t have an after-tax IRA because I didn’t see any advantage to having one and having one would complicate Roth-related rollover maneuvers. And if I have an after-tax 401K, I would roll it over to a Roth 401K as soon as possible.
Last Income Tax Form
Hopefully, my parents and siblings will ensure that my last Federal 1040 income tax form is filed. (I live in a state that does not have state income tax.) You can believe that the IRS will penalize a dead person (or beneficiary) for not paying taxes by the deadline.
I would suggest they hire a tax accountant to track down the necessary paperwork and to file the income tax form(s).
Revocable Living Trust
In the future, I might consider forming a revocable living trust. Such a trust would offer me greater control over how my assets, including physical possessions, are distributed while avoiding probate. The trust is revocable (allows changes) while I live, but becomes irrevocable (unchangeable) upon my death. The downsides are that the revocable living trust costs money to create and you have to go through the trouble of manually transferring assets to it.
I may wish to distribute my assets to my siblings, in addition to my parents. For example, I might transfer only my pre-tax IRA and pre-tax 401K to my parents. Because my parents are retired, they would pay less income tax on the distributions than my working siblings would. The remaining assets (including tax-free lump sum distributions from my Roth IRA/401K) would be distributed equally to my siblings. If I believe a sibling to be financially uneducated (unfortunately, every large family has one or two), their share would be equally distributed to their children instead. Likewise, if a sibling dies before I do.
I would definitely form a revocable living trust if I buy a house, get married, or have children. The real estate value would probably exceed the probate limit. A living trust is more ironclad than a prenuptial agreement (thinking this is probably why I am single). A living trust is very difficult to contest by children should they disagree with how you wish to distribute your money.
Note: Some states allow TOD registration for real estate, which would be much simpler and cheaper than a living trust.
A comprehensive revocable living trust could eliminate the need for a will. The existence of a will does not prevent probate. The probate process would proceed more smoothly with a will than without because there is no need to guess at your intentions.
The above mechanisms would work great if I die. What happens if I am incapacitated?
For the single person, a revocable living trust may be the answer. The living trust could contain an incapacity clause to allow the trustee to take charge of managing your assets. This would avoid a legal guardianship proceeding, followed by manual transfers of assets to the guardian.
I plan to setup the following in the near future:
- Power of Attorney – allows you to name someone to act on your behalf in legal matters; should be the same person as your incapacity clause trustee.
- Durable Power of Attorney for Health Care (Advance Directive) – allows you to name someone to make health care decisions on your behalf and contains instructions on how you want to be treated (Living Will).
- DNR (Do Not Resuscitate) and POLST/MOLST (Physician/Medical Orders for Life-Sustaining Treatment) – instructions on how you want to be treated, even though this may already be covered by the living will.
Finally, I plan to gather in one place: the documents above, how I wish my remains to be disposed of (cremation), an inventory of all my assets (companies and account numbers), and a will (whom my physical possessions should go to).
Some helpful websites:
- Inheriting an IRA: What Taxes Do I Need to Pay?
- Are 401(k) Plans Taxed When Death Occurs?
- How To Avoid Being Double Taxed On Your After-Tax IRA Contributions
- WTF Is a Will?
- Planning for Incapacity With a Living Trust
- Living wills and advance directives for medical decisions
- Share your final wishes, just in case.