How Property Transfers At Death

When you die, the way in which your property is handled will depend on the type of documents (or lack thereof) you’ve set up before your death. The following is a summary of the ways your property transfers to heirs when you pass away.

Life Insurance. At death, life insurance proceeds are passed to your beneficiaries (and in most cases, tax free). For example, if you have a life insurance policy with a face amount of $500,000, when you die, your beneficiaries receive the $500,000 face amount tax free.

When you purchase life insurance, you name your beneficiary or beneficiaries – those who receive the death benefit when you die. Most married couples will name each other as beneficiaries on their respective polices, some will name charities, and other will name other relatives, individuals, or trusts. Life insurance contracts generally avoid probate (the legal process of validating a will and division of property), unless you name your estate beneficiary (a bad idea) or fail to name a beneficiary (also a bad idea).

Annuities. At death annuities operate the same way as life insurance regarding beneficiaries. A big difference however, is the tax treatment. Even though an annuity may pay a death benefit, in most cases it is taxable to the beneficiary. This is different from life insurance death benefits that are received tax free. Any taxable annuity death benefits are taxed as ordinary income.

Trusts. Trusts can be established either during your lifetime or at your death. They may also be revocable (changeable) or irrevocable (not changeable). Trusts are set up by a grantor (the person wanting the trust) and assets are placed in the trust, managed by a trustee, for the benefit of the trust beneficiary. When you die, the assets in the trust are still managed by the trustee for the benefit of the beneficiary. Like annuities and life insurance, trusts avoid probate.

Brokerage Accounts. When you have a brokerage account where you hold stocks, bonds, mutual funds, or ETFs it’s called a non-qualified brokerage account. The non-qualified means that it’s not a 401(k) or IRA. When you open this type of account, you are given the option to name a beneficiary on the account should you die. At death, the property passes to the beneficiary. The beneficiary also receives special tax treatment on the account. Brokerage accounts also avoid probate.

Retirement plans. When you have retirement plans such as 401(k)s and IRAs you also name beneficiaries who get the account assets when you die. The tax treatment of the assets will depend on the account (Roth or not), and what the beneficiary chooses to do with the assets (sell them all or take minimum distributions). Brokerage accounts avoid probate.

Wills. A will is a written legal document that directs how and to whom your assets are dispersed after your death. Wills also name a guardian(s) for minor children should both parents die. Wills also name an executor for your estate that helps direct where assets go, what assets to sell, and filing the final tax return for the deceased and or the estate.

As mentioned before, probate is the process of validating a will. Thus, it’s a public process, and often long and expensive. Additionally, the documents mentioned above supersede the language in a will. In other words, if your will states that your kids get your IRA assets at your death, but your IRA beneficiary is another person or entity, the IRA overrides the language in the will.

Dying without a will means dying intestate. Dying intestate means that the state determines how your assets are divided, who gets them, and if you have minor children, who becomes their guardian. Different states have different laws, but be assured, the laws may differ from what your intentions are or who you think should get your assets or be guardians. Don’t risk it. If you don’t have a will, or your beneficiaries named, consider taking care of this today.

An extremely important point not to be overlooked is the need to update your beneficiaries or documents whenever you have a life changing event. Life changes mean births, deaths, divorces, job changes, etc. For example, if you get divorced and remarry, and forget to change your beneficiary from your ex-spouse to your new spouse – and you die – your ex-spouse is still the beneficiary and gets the property. It is paramount to update your accounts, estate documents, insurance policies, and retirement plans to reflect any life changes.