Pros and Cons of Joint Ownership of Assets for Estate Planning

Joint title is perhaps the most common form of Estate Planning. Lawyers often call it a “will substitute” and “the poor man’s will.” Unfortunately, joint title is not the best option for many people. In fact, it can be a bad option. Joint title can add risk and also can increase taxes on capital gains, estate, and gifts.

The key advantage of joint ownership for estate planning is that the property involved avoids probate. Probate is a process each state uses to clear title assets, ensure debts are paid, and transfer the remaining assets to either designated beneficiaries or the beneficiaries determined by state law. People want to avoid probate because it can be time-consuming and expensive. Many families have seen relatively small, uncomplicated estates spend over a year in probate. In many states, attorneys still charge a percentage of the estate’s value to perform the relatively routine paperwork processing of the probate process for estate planning.

In addition to avoiding probate, joint ownership avoids will contests. The title passes to the surviving joint owner automatically. If you are that rare individual who fears a will contest by his survivors, perhaps because of a second marriage, consider joint title.

Some property avoids probate automatically when you name a beneficiary other than your estate, such as pensions, annuities, and life insurance benefits. Otherwise, probate is avoided only by altering the form of ownership. The two most common ways to avoid probate are joint ownership and the living trust. We’ve reviewed living trusts in past visits, and you can find those discussions in the Archive section of the web site at www.retirementwatch.net.

To avoid probate with joint ownership, the title must use the magic words “joint tenancy with right of survivorship” or “tenancy by the entirety.” Tenancy by the entirety is available in only 30 states, and in many of those it is available only for real estate. There are a few differences between the two.

Joint tenancy with right of survivorship gives each owner full rights to the property. Either owner can unilaterally do whatever he or she wants. One owner can spend the cash in an account or sell property. Also, the creditors of either owner can claim the jointly-owned property.

With tenancy by the entirety, neither owner can do anything with the property without the other joining. This can be viewed as being either good or bad. It reduces flexibility, and it can create problems when one spouse becomes incapacitated. It protects the asset, however, from unilateral actions of one spouse.

There also is creditor protection in non-community property states. Creditors cannot reach the property held as tenants in the entirety unless each spouse is liable on the debt. If the non-creditor spouse dies first, however, the creditors then can reach the property. If the creditor spouse dies first, however, the other spouse gets full title and the creditors cannot touch the property. (In community property states, the result is the opposite. A creditor of either spouse can claim the entire property.)

There are disadvantages, primarily tax disadvantages, to either type of joint tenancy for estate planning.

You might incur gift taxes when creating joint title to property. If the other owner is your spouse, there is no problem because unlimited tax free gifts can be made between spouses. Giving joint title to a non-spouse, however, results in a gift unless the other person contributed his or her own property to obtain a share of the title. When you give someone an interest in a financial account, however, there is no taxable gift until that other person actually withdraws money or property.

Your estate might pay higher taxes because probate and estate taxes have different rules. Some property is excluded from your probate estate but is included in your taxable estate. To avoid both probate and estate taxes, you must give away the ownership, control, and benefits of the property. You don’t do that with joint ownership.

When property is owned jointly, your spouse automatically gets full title after your death. That means the lifetime estate and gift tax credit of the first spouse to die cannot be used on that property. The lifetime credit of that spouse is lost unless there is other property that is not jointly owned and is bequeathed to heirs other than the spouse. It also means the jointly-owned property and all its future appreciation will be in your spouse’s estate and potentially subject to future taxes.

Jointly-owned property also can increase income and capital gains taxes. One half of the jointly held property is included in the estate of the first spouse to pass away. The inherited half of the property gets its tax basis increased to its fair market value on the date of the first spouse’s death. The other half of the property, however, does not get its basis increased. If the surviving spouse doesn’t sell the property, records must be maintained to reflect the two different bases.

If one spouse owned the entire property, however, the basis of the property would be increased to its fair market value. Increasing the entire basis means the second spouse could sell the property without paying capital gains taxes. This is an important advantage with stocks, mutual funds, real estate, businesses, and other assets that increased greatly in value. (In community property states, the entire property gets a stepped-up basis on the death of the first spouse.)

Joint ownership does not have to be between spouses. With non-spouses, the form of title is known as tenants in common and has some different qualities. Some people hold property jointly with their children to avoid probate and as a will substitute. When property is owned jointly with a non-spouse, then the entire property is included in the estate of the first to die unless the other owner can show he or she contributed enough to buy a share of the property. Often, it would be cheaper to own the property outright and give it away in a will, using the lifetime estate and gift tax credit, than to use joint ownership in this way.

Also consider the non-tax consequences of joint ownership. The survivor has 100% ownership rights. That means the first spouse to die has lost any ability to control how the property eventually is disposed of or managed. The property could become part of a second marriage and go to a second family or to other people the first spouse never knew. The children of the marriage might never receive the benefits of the property. If the property were transferred by a will or trust, the first spouse to die could ensure that it would not go to a second family or to some other unwanted owner.

As a general rule, joint title to property with a spouse should be minimized if a couple has over $1,000,000 worth of assets. Spouses could jointly hold a checking account, savings account, and the principal residence. But give serious consideration to having each spouse own other property separately in equal amounts until each owns at least $1,000,000 of property.

The main reason to use joint ownership is to avoid probate. You need to compare the cost of probate with the other consequences of joint ownership. Many states streamlined the probate process in recent decades, especially for small and mid-sized estates. Ask an estate planning advisor how probate works in your state and how much it costs before deciding that joint title is the solution for you.

Also, compare the speed and low cost of joint title with its hidden costs. Then you can decide if this tool should be part of your estate planning.