As with many things, names have a lot of power. If you are trying to use beneficiary designations as a method of estate planning, please read this article.
Why Not Just Add a Child or Loved One to Your Accounts?
We often see instances where an elderly parent has added the name of a child or other loved one to their bank accounts, CDs or brokerage accounts. Normally the elderly individual is looking for a simple way to allow someone else to help manage their finances. When pressed, we often determine that it was not the intent of the older individual that the account would pass to a single individual, but rather that the person would manage the account and pay bills after death, but not to the exclusion of sharing any remaining funds with other beneficiaries.
What's Wrong With This Arrangement?
There is no legal requirement that a party named as the co-owner of an individual’s account use the money in the manner requested by the original account holder. It does raise a potential problem particularly where your intention was to make sure that your last bills and expenses were paid with this account, or that the added account owner would divide the assets of the account with his or her brothers and sisters.
Unless it can be clearly established to the contrary, generally when you add anyone as co-owner to an account, the legal assumption is that you gifted them half of the value of the assets within the account. If the value of one-half of the account is more than the annual exclusion (currently $14,000 per year per beneficiary) there is a requirement that the original owner file a gift tax return. Normally, there are not immediate gift tax consequences associated with naming another individual to an account but there is a technical requirement to file a gift tax return. In our experience, most individuals are not aware of this requirement, and it's actually somewhat unusual to see a gift tax return filed in these circumstances.
There's another issue that could be particularly important when adding the name of another individual to a brokerage account. Basically, when you add the name of another individual to an account, the individual is deemed to be half owner of the account with the same basis in the account as the original account holder; while this may not be a particular problem with bank accounts and CDs since there's no real basis issue with these type of assets, there can be a potential problem with brokerage accounts. Normally, when an individual inherits stocks or brokerage accounts at death, they get a stepped-up basis in the assets (i.e. the value at the date of the individual’s death or six months afterwards). However, if you add an individual’s name to the account during your lifetime, the asset is deemed to be gifted and the asset basis is the basis of the individual giving the gift.
As an example of this difference, if Mary has a $100,000 brokerage account and names her only son, John, as a co-owner of the brokerage account, she is effectively giving him one-half of the brokerage account. Let's assume that she has a basis of $40,000 in stocks in the brokerage account. That would mean John's basis in his one-half of the account is $20,000. After Mary's death when he goes to sell the stocks he would have a basis of $20,000 in half of the stocks and $50,000 (assuming the stocks are worth $100,000 at Mary's death). The beneficiary’s total basis would be $70,000 instead of $100,000 had he inherited the brokerage account at Mary’s death. Effectively, John would potentially be paying as much as 30% of $30,000 in federal and state taxes depending on his income bracket. If he received the brokerage account at the time of his mother's death, there would be no income taxes due when he sold the stocks assuming he sold the stocks at their date of death value.
Another issue to consider when you name a child or another individual beneficiary on any of your accounts is that one half of your account becomes subject to the claims of creditors of that individual. There are two situations you should especially look out for -- divorce and bankruptcy – because in these circumstances either creditors or the estranged spouse could wind up with a claim on part of your assets.
What's Another Plan of Action?
If your objective is to simply have somebody help manage your accounts, you should probably consider a durable power of attorney naming that individual with specific authority to manage the account during your lifetime. Most large banks have a form power of attorney limited to the specific purpose of managing a bank account. Under the laws of many states such as Pennsylvania and New Jersey, banks are required to accept durable general powers of attorneys or give specific reasons why they are not accepting them. The reasons to reject a durable power of attorney are very limited.
Another option is to use a Revocable Living Trust and move your assets, particularly bank accounts, brokerage accounts, CDs, etc. into the trust name. You could then name an individual you wanted to assist in managing the funds as a substitute or alternate trustee with the ability to act when you are no longer able to act on your own.
Generally, there are better alternatives to naming another individual as the co-owner of an account or as a co-owner of real estate. Most of the rationale stated above as related to bank accounts, CDs and stock accounts also applies to real estate. With real estate you need to be particularly wary of the gift tax consequences of making a transfer of interest in real estate during your lifetime. A better alternative may be to put your property in the trust, prepare a transfer on death or create a pay on death deed that effectively transfers your real estate to your named beneficiaries upon your death.