Do TOD and POD Designations Really Work?

“T.O.D.” (Transfer on Death), and “P.O.D.” (Pay on Death) designations have become common with most financial institutions.  These are essentially “beneficiary designations” like we usually see with life insurance, annuities, IRA and qualified plans.  At one time it was common for banks and brokers, not to offer these. When we used Revocable Living Trusts in planning, they would require that the account be re-registered in the name of the Trust.  By popular demand these designations are frequently offered today, and even when we have done Trusts, I usually regard these designations as the preferred way of titling accounts.

It is important to read these forms; ask the “what if” questions; and be certain that they do and say what we think they do

P.O.D. and T.O.D. forms are contractual in nature.  This means the institutions regard them as a contract and will follow them.  They will override the terms of a Trust or Will, and so must be carefully integrated with those documents.  The forms are almost always created and published by the institution itself, to fit their own particular goals.  The "devil is always in the detail."  Thus, as clients and as advisors, we need to read them carefully.  Every company will have a different agreement (indeed, the same company may well have different agreements for different products).

The forms are also often “generic,” “one-size-fits-all,” documents, for perhaps obvious reasons of economy.  In doing this, they often make an “educated guess” about what the “typical” client would want.  But that doesn’t always fit the desires of clients.  For example, they may provide for a beneficiary designation with “per stirpes” distribution in the event the beneficiary is not living (which has a very specific legal meaning).  The form may also call for a distribution of remaining assets to the other designated beneficiary(s).  Or, the form may not directly address this at all.  Even more problematic is the designation (directly, or as a result of the form’s default beneficiary designations) of minor or incapacitated individuals as beneficiary.  This may result in unintended and unexpected Probate proceedings.  I like to say that the forms do not always adequately answer the question: “what if?”  We have had some success negotiating with some of these companies to let us “custom draft” beneficiary designation forms to fit the desires of the client.  But what is critically important is to read these forms; ask the “what if” questions; and be certain that they do and say what we think they do (or should do).
 

“The Devil is always in the detail”

Generally, when designating a Trust as beneficiary, we can avoid these problems, by making the Trust the direct, primary beneficiary.  The Trust can be structured to address the “what if” questions, and have alternative disposition for unexpected situations.  For the majority of clients’ assets, my preferred method is to have them own the asset, with a T.O.D./P.O.D./beneficiary designation to their Trust.

IRA and “Qualified Retirement Plans,” “non-qualified annuities,” and some government savings bonds) do not “play well” with Revocable Trusts

There is a very important exception, however! There is one category of assets where naming the Trust as a beneficiary might be disastrous.  One of the unfortunate truths about Estate Planning is that our laws, rules and conventions are anything but consistent.  More consistent treatment of some of these things would make our jobs as planners easier, and the goals of our clients more certainly met.  But this would require the IRS, banks, brokers, insurance companies and state legislatures (among others) to all get on the proverbial “same page.”  Probably not gonna’ happen.  In this case, it is the IRS (really, Congress) that is the bad guy.  Surprise, surprise.  :-)

Certain tax-deferred accounts (namely, IRA and “Qualified Retirement Plans” [401(k), 403b, pensions, etc.], certain “non-qualified annuities,” and some government savings bonds) do not always, unfortunately, “play well” with Revocable Trusts.  I think this could be rather easily addressed by Congress and simplified.  Instead, they have chosen to go another way and have created perhaps the most complex “morass” of rules in the entire Internal Revenue Code.  This is another topic for another day, but suffice it to say that when these assets are involved, the proper beneficiary designation scheme should come under heightened scrutiny.

When the account owners are joint owners (typically Husband and Wife, but occasionally others), it is important that the form (or the institution’s policies) make clear what happens if one of the joint owners dies.  Presumably, the T.O.D. / P.O.D. would not be activated yet and the co-owner would continue to be the owner with the right to change or re-designate beneficiaries.  But the forms are not always crystal clear.  I recall an issue recently on an annuity contract where there were co-owners, but on the death of one of them, the contract required that the surviving co-owner re-designate beneficiaries.  No one ever raised that issue with her and she did not do so.  Instead, she assumed the original designation of one of her 4 sons was still valid.  On her death, that son made a claim.  The annuity company denied it and insisted that the proceeds be paid to her estate because since there was no re-designation, there was in effect, no designated beneficiary.  So it is very important the upon the death of a joint owner, the other joint owner(s) review and perhaps re-designate beneficiaries.

POD/TOD forms do not always adequately answer the question: “what if?”

The takeaway is that we must read the forms and not just rely on the fact that they are the “company standard form,” and therefore will always “work.”  It is also important to communicate with the institution if there are any questions or concerns.