I often refer to the Transfer on Death Designation (sometimes called a Payable on Death or “POD”) as the lowest hanging fruit of an estate plan. These designations are easy to set up and can be very effective. There are certain pitfalls, however, in using these designations that may prove costly to your estate.

Investopedia’s recent article entitled “Who Can Be a Transfer on Death (TOD) Beneficiary?” explains that, if you name TOD beneficiaries, it’s very clear who you want to receive your assets when you pass away.

TOD Designations: Simple Probate Solutions—or Complex Estate Pitfalls?

A TOD instruction allows your heirs to avoid probate for these assets. This will take precedence over anything in your will. This can make the legal process of distributing assets much faster than it otherwise would be.

You can name anyone as a TOD beneficiary. However, if you’re married, your spouse may have special rights over your assets that take precedence over your named TOD beneficiaries. These laws vary by state, though, so ask an experienced estate planning attorney. Another risk exists when naming a minor as a beneficiary. While the TOD may avoid probate, it may require a local court to appoint a conservator to manage the young beneficiary’s inheritance. This process is also time consuming and expensive.

Naming TOD beneficiaries can certainly simplify asset transfer after death, but it’s essential to consider how these accounts fit into your larger estate plan. For example, many TODs don’t allow for contingent beneficiaries. If your primary beneficiary passes away and you haven’t updated your designation, the account could end up in probate—defeating the original purpose. Additionally, if multiple TODs are created across various institutions, they can be forgotten or unclaimed unless you maintain a master list and share it with your executor or a trusted individual. Without thoughtful coordination, TODs may unintentionally disrupt your estate’s balance or leave your executor without enough liquidity to cover important expenses.

Your TOD beneficiaries will also be responsible for paying taxes on the money they receive. This will complicate their tax situation and may also mean a large tax bill for them.

Remember that a transfer on death (TOD) beneficiary can be a person, charity, business, or trust. If the beneficiary is a person, they can be a relative, child, spouse, friend, or anyone else you happen to know. But again, if you’re married, your spouse may have special rights over your assets that take precedence over your named TOD beneficiaries, according to state law.

Contact your account provider to see if you can add a TOD beneficiary. It’s available for many account types—not only retirement accounts but also certificates of deposit (CDs), savings accounts and brokerage accounts.

Naming a TOD beneficiary (or several) can have advantages during the inheritance process, since this makes it very clear who you would like to inherit your assets. These funds can then be distributed without passing through the potentially costly process of probate. It can make the inheritance process much simpler because your named beneficiary will automatically receive the assets in the account—bypassing probate as a result.

While TOD accounts offer a quick way to pass assets to loved ones, they’re not a one-size-fits-all solution. Be sure to revisit these designations regularly and work with an estate planning attorney to ensure they align with your overall goals and avoid unintended consequences.

Reference: Investopedia (May 19, 2022) “Who Can Be a Transfer on Death (TOD) Beneficiary?”