Investors often contribute to their brokerage accounts over several decades, accumulating wealth for retirement and aiming to leave a financial legacy for their heirs. While focusing on wealth accumulation is essential, it is equally crucial to understand the fate of those brokerage accounts after one’s passing.
The process by which heirs receive funds is contingent upon the registration of the account. Accounts may include transfer-on-death (TOD) provisions, enabling account holders to designate a beneficiary who can directly receive the assets outside of probate— the legal procedure for settling an estate post-death. In the case of joint accounts, the surviving owner typically maintains control through survivorship rights. For accounts held in a trust, the successor trustee assumes control according to the trust’s terms.
If no beneficiary is designated for an individual account, complications may arise, and the account could enter probate, a process that can be lengthy and costly.
To avoid common pitfalls, it is advisable to appoint a TOD beneficiary for your brokerage account and to update this information following significant life events such as a divorce. It is also essential to confirm that the TOD registration is correctly established with the brokerage, as variations in state laws and firm policies may apply. Notably, the beneficiaries designated in a brokerage account override any instructions in a will, making it vital to amend the TOD beneficiaries directly as needed.
Consulting an estate planning attorney and a financial advisor can assure that all necessary steps are followed, facilitating a smooth transfer of assets to heirs.
Most heirs typically do not need to be immediately concerned with taxes regarding a brokerage account. As Roger Young, thought leadership director at T. Rowe Price, explains, the notion of cost basis—the initial price paid for an investment—shifts upon the owner’s death. The investment’s value at that time becomes the new cost basis, allowing heirs to enjoy tax-free gains accumulated during the original owner’s lifetime, a concept known as “step-up in basis.”
Different rules apply to tax-deferred accounts. The IRS typically mandates that non-spouse beneficiaries withdraw all funds from an inherited IRA within a decade. They may also be subject to required minimum distributions (RMDs) depending on whether the original owner had initiated them. Furthermore, withdrawals from traditional IRAs will be treated as taxable income.
To ensure that all accounts are directed to the appropriate heirs, reviewing beneficiary documentation is advisable. Engaging with a brokerage’s estate processing team can clarify required documents. If an inheritance is received, confirming the cost basis of the assets prior to any sales is also prudent.