Choosing the best account type
Q: My partner and I are looking to open a brokerage account, but we are confused about which type of account is best. Can you explain why one is better than another?
A: I can only give you a cursory overview of account types in this column, but more extensive information can be found online. Even better would be to work personally with a knowledgeable professional—someone who can help you get the right kind of account for your unique situation.
You mentioned that this account would be for you and your partner. The nature of your legal relationship makes a difference for this discussion. If you are married or are in a registered domestic partnership, a broader array of account types will be open to you. If you are not in a formal legal arrangement, you will not be able to open community property accounts. Many of the limitations associated with various account types can be finessed with an appropriately structured living trust, but that’s a discussion for another day.
Individual account – These accounts permit only one owner but would give each of you complete control over the assets in your account. Because these accounts designate no beneficiaries, they must pass through probate upon the death of the account owner.
Transfer on death (TOD) account – An individual account can be modified to provide for a beneficiary upon the account holder’s death. The assets in the account pass to the named beneficiaries without going through probate. TOD beneficiaries can be individuals, trusts or charities.
TOD accounts can be tricky. For example, minor children cannot legally receive investments from a TOD account unless they have a court-supervised guardian. At age 18, they get complete unsupervised access to everything in the account. What could possibly go wrong with that?
Joint tenants with right of survivorship – This is an easy way for two or more people to own an investment account together. It avoids probate if one of the parties dies before the other, because the surviving party automatically inherits the interest of the deceased party. However, joint tenancy has some serious limitations and should be used with great care.
For example, a joint tenant on your account has ownership of the assets in the account. Without your knowledge or approval, the joint tenant can buy and sell assets, even remove money from the account. If you don’t like it, you are stuck.
Your joint tenant’s creditors also have complete claim on the assets. If a judgment is made against your joint tenant, the creditors can take your assets to satisfy their claims.
Another problem is that spouses who own assets as joint tenants are likely to lose a significant tax benefit when the first spouse dies. Since each spouse owns half of the assets in the account, when the first spouse dies, the inheriting spouse only gets a step up in basis on the decedent’s half of the assets.
Community property – Community property is a unique form of ownership available in a handful of states, including California. Community property applies only to married spouses or registered domestic partners. Community property accounts are jointly owned. However, unlike joint tenants, parties to a community property account get a full step up in basis upon the death of the first spouse or partner. Community property has no inherent right of survivorship. The spouse or partner can will away their share without the knowledge of the surviving spouse/partner. Consequently, community property accounts pass through probate on the death of the first spouse/partner.
Community property with right of survivorship – In California, community property can be combined with a right of survivorship. This means that the surviving spouse has the right to inherit ownership of the assets in the account. The decedent’s portion cannot be willed away to someone else and the account does not need to pass through probate.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to firstname.lastname@example.org.