Wealth Events
Understanding account types and registration is essential because those choices directly affect what happens when a major life event occurs, particularly the death of an account holder. This section covers inheritance rules, step-up in basis, and Transfer on Death designations.
Inheritance
When an account holder dies, the account is typically frozen pending receipt of required documentation:
- Death certificate
- Letters testamentary (court document authorizing the executor to act)
- Other estate documentation as needed
What Happens Depends on Registration
| Registration | What Happens to Assets |
|---|---|
| Joint Tenants with Right of Survivorship (JTWROS) / Tenancy by the Entirety (TBE) | Surviving owner receives assets automatically (no probate) |
| Tenants in Common (TIC) | Deceased owner's share passes to their estate (subject to probate) |
| Transfer on Death (TOD) | Named beneficiaries receive assets directly, bypassing probate |
| Individual (no TOD) | Assets pass through the owner's estate (subject to probate) |
Exam Tip: Gotchas
- JTWROS and TBE avoid probate; TIC and individual accounts do not. This distinction is frequently tested.
- Retirement accounts have their own beneficiary designations separate from TOD.
Step-Up in Basis
- Inherited securities generally receive a step-up in basis to fair market value on the date of death
- This reduces capital gains liability for the beneficiary
- Example: An investor bought stock at $20/share. At death, it is worth $80/share. The beneficiary's cost basis becomes $80. If they sell at $85, they only owe capital gains on $5/share (not $65)
Think of it this way: The IRS essentially "resets the clock" on inherited investments. No matter how much the original owner gained, the heir starts fresh at the death-date value. Only growth after that point is taxable.
Exam Tip: Gotchas
- Step-up in basis resets the cost basis to fair market value at death. The beneficiary does not inherit the original purchase price.
Community Property States
- In community property states (~9 states), both halves of community property may receive a step-up in basis at death, not just the deceased spouse's half
- This is a notable tax advantage compared to other joint ownership forms
Exam Tip: Gotchas
- Community property states give a full step-up on BOTH halves (not just the deceased spouse's half). Other joint ownership forms only step up the decedent's share.
Transfer on Death (TOD) Designation
- Allows an account holder to name beneficiaries who receive account assets upon the holder's death
- Available for individual and joint accounts
- Not typically available for retirement accounts (which have their own beneficiary designations)
- Beneficiaries have no rights to the account during the owner's lifetime
TOD Priority Rules
- TOD supersedes a will. If the will and TOD designation conflict, the TOD controls
- Example: A customer's will says "divide equally among three children," but the TOD names only one child. That one child gets the entire brokerage account
- The TOD designation also takes precedence over trusts, premarital agreements, and other legal documents (unless overridden by court order)
Exam Tip: Gotchas
- A TOD designation overrides a will. This is one of the most commonly tested concepts. If the will and the TOD conflict, the TOD wins every time. The only exception is a court order.
- Beneficiaries have no rights to a TOD account while the owner is alive.