Avoiding probate has much to recommend it. But it's not a magic bullet that solves every financial problem that might surface after your death. To clear up some common misconceptions, here are a few things that probate-avoidance has absolutely no effect on.
Avoiding probate doesn't mean avoiding taxes. In fact, the two are completely unrelated. If you give away a lot of money during your life, or leave a lot at your death, the state and federal governments may take a chunk of it in the form of gift or estate tax. The IRS and the states don't care whether or not the property goes through probate court on its way to the people who inherit it.
Most people don't even need to think about federal gift and estate taxes. These taxes affect only people who make very large amounts of taxable gifts during life or leave very large estates (worth millions) at death. State taxes, however, may affect smaller estates.
Your Family's Right to Inherit
Family members, in some circumstances, have a right to claim some of the property you leave at your death, and using probate-avoidance techniques to transfer the property doesn't change that. This, of course, is no problem for most people; most of us want very much to pass on to our spouses and children whatever wealth we've accumulated.
Spouses. Spouses’ rights vary from state to state. In the community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), the general rule is that spouses together own most property that either acquires during the marriage. Each spouse owns a half-interest in this "community property." You are free to leave your separate property and your half of the community property to anyone you choose.
In most other states, a surviving spouse who doesn't receive at least one-third to one-half of the deceased spouse's property (through a will, living trust, or other method) is entitled to insist upon that much. The exact share depends on state law.
Children. You don't have to leave your children anything, although of course most parents do. If any children appear to have been accidentally overlooked—typically, children born after the parent's will is signed—they may be entitled to a share (the size is determined by state law) of the deceased parent's assets.
If you don't want to leave any property to one or more of your children—perhaps they have plenty of money, or you've already given them their inheritances—just make a will and mention each child in it. And to avoid any later misunderstandings or hurt feelings, explain your actions to your children, either in your will or better yet, now.
Grandchildren. Grandchildren have no right to inherit from their grandparents unless their parent has died. In that case, the grandchildren essentially take the place of the deceased child and are entitled to whatever he or she would have been legally entitled to, if anything.
For more on surviving family members’ rights, see Inheritance Rights.
Avoiding probate doesn't let you off the hook from legal obligations to your creditors. If you don't leave enough other assets to pay your debts and taxes, any assets that passed outside of probate may be subject to the claims of creditors after your death.
If there is any probate proceeding, your executor (the person named in your will to handle your affairs after your death) can demand that whoever inherited the property turn over some or all of it so that creditors can be paid. Creditors, however, have only a set amount of time—about three to six months, in most states—to submit formal claims to your executor. A creditor who is properly notified of the probate court proceeding cannot file a claim after the deadline passes.
On the other hand, when property isn't probated, creditors' claims aren't cut off so quickly. In theory, at least, a creditor could track down the property and sue the new owner to collect the debt a year or two later.
EXAMPLE: Elaine is a real estate investor with a good-sized portfolio of property. At any one time she has many creditors, and she has been sued twice. It might be to her advantage to have assets transferred by a probate court procedure, which requires creditors who are properly notified of the probate proceeding to file their claims promptly.
As a practical matter, however, avoiding probate may actually provide more protection from creditors. When property is distributed without probate, there is no legal requirement (as there is in probate) that creditors be notified in writing. They may not know of the death for years. They may not know where the property went, and especially if the debt is small, it may not be worth their while to track down the new owners and try to collect.
Most people don't need to worry that after their death, creditors will line up to collect large debts from the estate. In most situations, the surviving relatives simply pay the valid debts, such as monthly bills, taxes, and medical and funeral expenses. But if you are concerned about the possibility of large claims, you may want to let your property go through probate.