Understanding Pro Rata vs Per Stirpes

Exploring the Distribution Methods for Estates

Distributing an estate can be confusing if you’re unfamiliar with the distribution language. Two common methods used for estate distribution are per stirpes and pro-rata. In this article, we will delve into these two distribution formulas and unravel the difference between them.

Per Stirpes: Who Gets a Share of the Distribution

Per stirpes is a distribution formula that determines who is entitled to a share of the estate. Imagine you have a beneficiary named in your will or trust, and they pass away. With per stirpes, their share of the estate goes to their children. Let’s bring this to life with a hypothetical example.

Meet Jack and Jill, who have three children: Bill, Sue, and Bob. If Jack and Jill’s trust states “to our children in equal shares, by representation,” it means that as long as all three children are alive when Jack and Jill die, they will split the estate equally. However, if Bill were to pass away before his parents, his share would be inherited by his children. It’s like passing the baton of inheritance to the next generation.

Visual representation: Chart 1

Pro Rata: How Much of Each Asset Each Person Receives

On the other hand, pro-rata refers to the distribution formula that determines how much of each asset each beneficiary receives. Suppose Jack and Jill have a home, a bank account, and life insurance. With pro-rata distribution, each eligible beneficiary receives an equal share of each asset.

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Let’s revisit our example: Bill, Sue, and Bob. If Jack and Jill’s trust states “to our children in equal shares,” it means that each child will receive an equal portion of the house, bank account, and life insurance.

Visual representation: Chart 2

In case one of the children passes away, per stirpes comes into play again. For instance, if Bill were to pass away, his children would inherit his share, divided equally among them. Let’s visualize this scenario with a pro-rata distribution:

Visual representation: Chart 3

Non-Pro-Rata Distribution: Equal Distribution, Different Assets

There’s another method called non-pro-rata distribution, which doesn’t imply an unequal distribution but rather an equal distribution from different assets in the estate. To better understand this concept, let’s consider the following example:

Suppose Jack and Jill’s estate is worth a total of $1,500,000, and each child should receive an equal share of $500,000. With pro-rata distribution, this means each child would receive 33% of the house, bank account, and life insurance.

However, there’s an alternative approach. In this case, Sue keeps 100% of the bank account and life insurance, while Bob and Bill split the house 50/50. This way, each child still receives an equal 33% of the entire estate, but the assets are divided differently.

Visual representation: Chart 4

Tax Implications of Non-Pro-Rata Distribution

It’s important to note that non-pro-rata distribution can have significant tax implications, depending on the circumstances. Let’s explore one particular tax aspect related to property tax reassessment.

In California, Proposition 13 prevents property tax reassessment until the real property is transferred or sold, with exceptions like transfers between parents and children. When a will or trust conveys an estate to children in “equal shares” (pro-rata), it’s considered a gift, resulting in no property tax reassessment.

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However, if the beneficiaries decide to distribute the assets unequally (non-pro-rata) and choose a buy-out option, a property tax reassessment may occur. To avoid this, the non-pro-rata distribution must be executed by the estate, with no side deals between beneficiaries.

In Conclusion: Understanding Per Stirpes vs Pro-Rata

In summary, per stirpes and pro-rata are two distinct but interconnected methods of estate distribution. Per stirpes determines who inherits a share if a named beneficiary passes away, while pro-rata divides each asset equally among the eligible beneficiaries.

By recognizing the presence of phrases like “by representation” or “in equal shares” in distribution clauses, you can identify whether the distribution is per stirpes or pro-rata. It’s crucial to exercise caution when considering non-pro-rata distribution, as improper execution can lead to increased property tax bills.

Understanding these distribution methods empowers you to navigate the complexities of estate planning and make informed decisions that align with your wishes and the best interests of your beneficiaries.