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Funds in the afterlife
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October 28, 1998: 9:56 a.m. ET
Stocks and mutual funds can benefit your loved ones even after you're gone
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NEW YORK (CNNfn) - People planning their estate often assure their homes and cash will be passed on according to their wishes, but they aren't always as careful about where they bequeath their investments.
Passing equities along to survivors has often been an unwieldy proposition when people are setting up their wills and other estate planning.
But even if making allowances for your investments is difficult, it's very important to do if you want to ensure those investments don't end up floundering in probate court.
Probate, through which most of your assets must pass (unless you've set up a living trust) has brought frustration to many an ordinary investor when planning estates.
During the process, the court assesses whether your will is acceptable. Your assets and liabilities will also be presented before the court, usually by your executor. If anyone claims you owed them money, they can step forward during this time.
Probate may clear up your finances, but it can also be a grueling and expensive process. It may take months before your estate has cleared probate and the process itself can eat up more than 5 percent of your estate.
Because the probate process can be so cumbersome, investors have sought out ways to keep their hard-won investments out of it.
Into the fray stepped the National Conference of Commissioners on Uniform State Laws (NCCUSL), a Chicago-based legal organization. In order to make it easier for people to pass on their stock holdings, it came up with a proposal know as the TOD Security Registration Act.
The TOD, or transfer-on-death, proposal allows for investment securities -- stocks, bonds, mutual fund shares and security accounts -- to be transferred to named beneficiaries while avoiding probate.
"This is a very simple way to make transfers at death," said John McCabe, legal counsel and legislative director for the NCCUSL.
McCabe's organization has had a great deal of success getting its proposals accepted. Since its introduction in 1989, 42 states have adopted legislation establishing the TOD measures, with bills currently pending in three other states.
States with TOD legislation
The NCCUSL didn't face an uphill battle everywhere to get its proposals accepted, but in some states, particularly New York, there has been great resistance to TODs.
This is because a lucrative cottage industry surrounds the probate process in many states, according to McCabe.
"There is a suspicion about anything that takes something outside of the probate courts," said McCabe. "The bottom line is nobody gets fees."
Rights of survivorship
It's not as if there are no other ways for investors to pass on their stock holdings onto beneficiaries, but the current methods have one drawback that might make some investors nervous.
Investors currently have the option of opening a brokerage account with a joint tenancy with rights of survivorship (WROS) and, indeed, about 30 percent of brokerage accounts are opened using joint tenancy.
Joint tenancy is usually used by married couples but can be established as well between a parent and a child (if the child is a minor, you must establish a guardian until the child comes of age).
When one of the joint tenants dies, the security is then passed onto the other without going through probate. This may sound perfect but there's one possible flaw with this method.
Under joint tenancy you don't just pass on rights to the stocks or fund shares after death. You also pass on rights during your life.
This means the other joint tenant has the right to make decisions about the stocks in the same way you do.
A wife could sell shares without getting the permission of the husband, or vice versa. A child could sell off mutual fund shares held by an elderly parent.
Additionally, if a husband and wife were joint tenants, that legal arrangement wouldn't automatically be severed if they were to divorce, possibly creating an even greater legal entanglement at the end of a marriage.
Even under the best of circumstances, the tenants could find themselves clashing over management of the stocks. Because of these potential conflicts, the NCCUSL drew up the TOD proposal.
The main difference with the TOD is the rights to the securities are only transferred upon the death of the shareholder. While the stockholder is still alive, he or she retains full control of the stock.
In addition, the probate process might result in your securities being sold. Oftentimes, the mutual fund shares or stock have great earning potential and your beneficiaries might not want them sold off.
Making the switch
Establishing a transfer-on-death account is relatively simple. You'll just need to contact your brokerage or mutual fund company.
They'll send you a beneficiary form to fill out. Usually you can specify up to three people who can inherit your shares. If you're making a minor your beneficiary, be sure to specify a guardian.
Upon your death, your beneficiary will have to provide proof of death (as specified by the fund firm or brokerage) in order to have the final transfer made.
Don't assume, however, that just because your state has adopted the TOD statute you'll be able to set it up. Mutual fund companies are not required to give you the TOD options.
For those of you investing money through your employer in 401(k)s, however, the federal government mandates that you are allowed to pass on your holdings through TODs.
One size doesn't fit all
While the transfer-on-death accounts might seem to be the perfect solution, there are some drawbacks that keep it from having unanimous support.
First of all, don't assume skirting the probate process means skirting taxes. Estate taxes will still be applicable and by passing on these assets in their entirety, you may be increasing the tax burden on your beneficiary.
Not everyone is sold on the idea of TODs. "I rarely use them," said Richard Ploss, a certified financial planner in Bedminster, N.J.
Ploss' main concern about TODs is they are not right for everyone's needs.
"For smaller estates, they're probably fine but for larger estates with more sophisticated financial planning needs, they're probably too 'one size fits all.'"
Ploss said the probate process can be important in sorting out many issues which may arise on someone's death. He also explained that keeping all of your investments out of probate can be a mistake. Investments falling within probate may be sold and used to defray some of the costs of that process.
Despite these issues, the NCCUSL's McCabe expects the transfer-on-death to become more and more popular as knowledge of it increases.
"History has generally shown that if you give people the chance to avoid probate, they will. This is a very simple way for people to do that." 
-- by staff writer Randall J. Schultz
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