It’s possible that you may have a jointly held account, but not realize it’s the wrong kind of jointly held account, which could have important implications for your money and your legacy.
It’s surprising but not all joint accounts work the same. When it matters most is when someone dies, tries to get a loan, or gets sued. In other words, “joint” doesn’t always mean the same thing.
There are several common ways accounts and property can be owned jointly, and the differences can become especially important when it comes to taxes, inheritance, and estate planning.
Basic Principles
A note to bring up, I am not an attorney, nor a CPA. I’m a financial planner who looks at this joint registration choice based on a financial planner's point of view. As always, you should seek legal advice and tax counsel when making decisions. This is just for information purposes. And hopefully, we won’t speak legalese and will make this somewhat convoluted approach more palpable.
Our financial planning firm, IWM Financial, primarily focuses on retirement planning in the state of California. California is a community property state. So are Texas, Arizona, Nevada, and a handful of others. Community property works differently than in Common-law property states.
Since I’m in California, we might as well try to understand the law with examples of America’s favorite magical couple, Mickey and Minnie Mouse. I’m not sure if Mickey and Minnie are actually married; based on a lot of the cartoons, it seems like they’re actually in a long courtship, but we’ll assume they are married for the purposes of this example.
Let’s get a definition on the difference between Community Property and Common-law, as defined by the IRS first 1:
Community Property - Generally, defined as all property acquired during marriage while the spouses are domiciled in a community property state and that is not established to be separate property. Community property is the default characterization of all marital assets.
Common-law - The dominant property system in the United States adopted by the 41 states that are not community property states. Each spouse is treated as an individual with separate legal and property rights. Generally, each spouse owns and is taxed upon income that he or she earns.
Now, I’m mostly going to reference the Community Property Rules here on out.
Joint-ish Accounts
There are five common ways we see property and brokerage accounts held.
Joint with Rights of Survivorship (JWROS)
Joint with Rights of Survivorship (JWROS) is by far the most common way we see property and accounts held. Consider Mickey and Minnie Mouse, if they get married and change their bank accounts to joint, and start saving into a joint investment account, most often in California this is going to be a Joint with Rights of Survivorship account. If they buy a house, they can title the house as JWROS.
At this point, within JWROS, all of the accounts are 100% owned by Micky, and 100% owned by Minnie. So if Minnie wanted to use all of the funds, with or without Mickey’s knowledge, to open and fund a bow shop, she could do so. . They each get full discretion on the money.
If Marvin the Martian abducts Mickey Mouse, , and he sadly is declared deceased, then Minnie will need to know how the accounts and property is titled. The Rights to Survivorship in JWROS allows Minnie Mouse to continue their accounts. It’s still 100% her money. The accounts do not need to go to probate.
Even if Mickie wanted 50% of each account to go to Pluto, when he passes away, all of the money is left to Minnie. That’s an important distinction.
When Mickie is deemed to have passed away, the basis of his 50% would generally step up, meaning Minnie gets his basis tax-free (assuming we’re under the estate limit).
In California, Mickie and Minnie get a full step up in basis at the first death because of the Community Property rules.
Tenants in Common (TIC)
Now let’s assume that Mickey Mouse and Donald Duck go into business together and invest into a theme park. The initial investment needed is $1,500,000. Mickey is going to put in $1,000,000 of that, and Donald is going to put in $500,000. They are going to put these funds into a Tenant in Common (TIC) account.
When we open up TIC accounts, we put in writing on the account who owns how much of the account, and make sure there is a Transfer on Death (TOD) on file.
While the investment operates, Donald could choose to take a withdrawal from the account to use the capital elsewhere. Since he is a co-owner, he can generally make withdrawals without Mickey’s approval. However, he would typically only be entitled to withdraw funds consistent with his ownership interest.
If Marvin the Martin comes and abducts Mickey again, the Tenant In Common rules will work differently than JWROS. As long as Mickey has one of those Transfer On Deaths (TOD) on file and named Minnie as his beneficiary, Mickey’s share would avoid probate and pass to Minnie. If they owned physical property together, such as a house, where a TOD designation isn’t available, Mickey’s share would generally have to pass through probate.
The Potential Problems
You might be able to see some of the potential issues here.
What if one of the joint holders is an unscrupulous character and chooses to run away with the money?
(sorry for throwing Minnie under the bus in the JWROS example. I don’t want the Minnie Moms coming after me. I stand by my decision of Donald Duck though)
What would happen if no beneficiary is left on file?
What happens if one owner of the JTWROS wants to choose their beneficiary?
What would happen if there was a divorce?
There’s a ton of issues that could come up. One common way to avoid these issues is by opening a trust. A trust is a legally binding document that helps curtail a lot of these potential issues. When it comes to trusts, we highly recommend you work with an estate attorney to make sure it’s set up correctly.
Putting it All Together
Included here is a comparison table that puts all of this in one place.
As you can see, how you title your accounts is an important decision. Depending on where you live and how an account is opened, the default registration may determine what happens to your money. That’s why it’s worth being intentional about how your accounts are titled rather than simply accepting the default.
These decisions are an important part of your overall financial plan.They affect potential taxes, income, investment choices, balances, insurance, and estate planning. We recommend you work with a financial planner to help navigate this, and guide your financial plan.
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1. https://www.irs.gov/irm/part25/irm_25-018-001?utm_source