Estate Planning - Why Avoid Probate, And How

“Everything is either a problem or an opportunity. Wisdom is manifested as the ability to discern the difference and the capability to handle both."
― David Brewer

“Let everyone sweep in front of their own door, and the whole world will be clean."
― Johan Wolfgang von Goethe

You are getting your financial house in order and want to put your estate documents together. Logically, you set up a meeting with a financial planner or estate attorney. One of the first things you are likely to hear is that you should structure your estate plan to avoid probate court- the formal process by which a deceased person’s property is distributed among their heirs. So, you might ask, “Why avoid probate?” The four main reasons concern time, cost, privacy, and control. Let’s go through each and then discuss the six asset types that are structured to avoid the probate process.

Next post we’ll build on this material and address the two primary solutions you can use to avoid probate.  We’ll then highlight the unique advantages of a living trust for parents with minor children. The final post will cover the actual steps of establishing a living trust for parents with minor children.

Four Reasons to Avoid Probate

The four main reasons to avoid probate include:

Time – “The wheels of justice grind slowly.” You hope that when you pass away, your heirs will not have to worry about when they are going to be able to access funds, especially if they are needed to care for family. Probate courts supervise a process that includes several steps. Throughout this process multiple documents and forms will be filed. Probate proceedings take somewhere between seven months to two years. During this time heirs’ assets will not be distributed or sold without legal supervision.

Cost - Most probate proceedings will require both an Executor and an Attorney to guide the proceedings through the legal process and distribute assets to heirs. In this state, per the California probate code (§ § 10810, 10811), attorneys charge a “statutory fee”—an amount that is a percentage of the value of the assets that go through probate. The schedule is as follows: 4% of the first $100,000, 3% of the next $100,000, 2% of the next $800,000, 1% of the next $9,000,000 and .5% of the next $15 million. By example, if you have a home worth $800,000 and $200,000 of additional assets that are subject to probate, your fee would be $4,000 + $3,000 + $16,000 = $23,000. This fee would be standard regardless of the equity you have in your home (or how much it is actually worth to your heirs once sold). Keep in mind that an executor can also charge up to the attorney’s statutory fee. As a result, total fees can be double the statutory fee!

Privacy - Probate is a public process allowing friends, family, creditors, and unrelated interested parties to ascertain both the nature of your estate and how it is distributed. This can quickly cause tension and conflict if not everyone agrees that the process was ‘fair’ for them.

Control and Ease of Transfer – Even if you have a valid will, it is the court who ultimately decides how to distribute your assets. The judge who adjudicates the process will not know the nature of the relationships you have with your family and friends. They’ll simply use their best judgement to decide what you would have wanted. If you have a will, this document will serve as a guide, though it won’t negate the cost, time, and loss of privacy.

The Six Asset Types That Avoid Probate

Now that we’ve established why avoiding probate is beneficial, let’s talk about how you can avoid it. We will address six of the common types of assets that avoid probate altogether and pass directly to the beneficiaries.

1. Retirement Accounts (i.e. IRAs, 401ks, Pension Plan Distributions) for which a proper beneficiary was named will transfer directly to the beneficiary. Depending on the type of account, beneficiaries may be required to withdraw funds according to terms and timelines defined by the IRS.

2. Life insurance proceeds and annuity payouts. One of the advantages of life insurance above other types of assets transferred at death is the instant tax-free liquidity life insurance provides. Usually within two weeks of receiving a copy of the death certificate the insurance company will issue funds, or an alternate distribution plan selected by the beneficiary. Note that it will be the beneficiary’s responsibility to notify the life insurance company of the insured person’s passing. So if you have life insurance, make sure to let the designated beneficiaries know that you have it, and how they will need to notify the life insurance company.

3. Investments in accounts registered in Transfer-on-Death form, as Totten Trusts, or titled as Joint Tenancy with Rights of Survivorship (JTWROS). If an account lists several co-owners, the entirety of the assets in such accounts transfers to the remaining co-owner(s) at the time of one co-owner’s death. This will not avoid estate taxation for the deceased’s estate, but it does simplify the process. Additionally, the deceased’s portion of the assets receives a step up in tax basis, which has positive tax ramifications when the asset is ultimately sold.

4. Cumulative Assets under $150,000. California probate code allows for heirs and beneficiaries of estates with under $150,000 in cumulative assets that would otherwise be subject to probate court to file a simplified procedure with the Superior Court asking for an order to determine their right to take the property without probate administration.

5. Assets Titled To A Living Trust. A revocable living trust appoints a trustee with administrative powers to distribute assets titled to the trust according to the grantor’s wishes. Note that for jointly owned assets, the joint-owners will need to set up the Living Trust together. The grantors maintains control of the assets during their lifetime and upon their death whatever is titled to the trust is distributed according to the trust documents. In broad strokes, a will provides direction for probate, while a trust avoids probate altogether.

6. Real Property (land and buildings) subject to a Transfer-On-Death deed. In California, this type of deed allows property ownership to transfer ownership while bypassing probate. If you refuse to set-up a living trust, retitling the deed to your real estate with a Transfer-On-Death deed allows you to still transfer this property while avoiding probate.

That wraps up our discussion of why we should avoid probate, and which asset types by their nature automatically avoid probate process. We’ll build on this material in the next post to illustrate a few strategies for avoiding probate.