Joint Accounts: What You Need To Know
At first glance, establishing a joint account may seem like a great strategy for managing financial affairs during your lifetime and/or saving “probate fees” at death. However, there are a number of factors you should consider before taking this action.
This article will explore the use of ‘joint accounts’ and some of the related estate planning, control and tax issues.
What are joint accounts?
There are two types of joint accounts:
- Joint Accounts With Tenancy in Common
- Joint Accounts With Right of Survivorship
With tenancy in common arrangements, each joint owner may or may not own equal parts of the asset. When one joint owner dies, their share is left to their beneficiaries as set out in their Will or the rules pertaining to intestacy. This ownership arrangement is sometimes used, for example, in cottage succession plans. Parents may choose to bequeath their cottage to their children as tenants in common in the hopes that each child will in turn bequeath their share to their children.
The more common type of joint ownership is joint tenancy with rights of survivorship. In this case, each individual has equal ownership and control of the assets. Upon the death of one joint owner, the surviving joint owner(s) 'automatically' receives ownership of the deceased’s portion of the assets. Although the joint owners do not need to be related, this structure is most commonly seen between spouses and, sometimes, between parents and their adult children. It should be noted that this type of ownership is not available in Quebec.
Why open a joint account with right of survivorship?
There are several reasons people consider joint accounts. Between spouses, at least in a first marriage situation, such accounts can be convenient and practical both during the couples’ lifetime and at death. Where all assets are jointly held, a Power of Attorney for Property may not be necessary, so long as at least one spouse is capable of managing the assets. Because the asset ‘automatically’ passes to the survivor, the asset essentially bypasses the deceased’s estate and the probate process. For this reason, many people open joint accounts to minimize or avoid having to pay probate fees (probate rules and fees vary from province to province). However, despite the attraction, caution should be exercised before placing accounts in joint ownership. Here are some of the issues you need to consider:
• As a general rule, any joint owner is able to withdraw funds from the joint account at any time and does
not need the permission of the other joint owner to do so
• Where the asset is real property and the joint owner does not reside in the home, the transfer may result in a partial loss of the principal residence exemption. Moreover, it may not be possible to arbitrarily ‘undo’ the transfer, should the transferring party have a change of heart
• Assets held in a joint account may form part of creditor proceedings if one of the joint account holders becomes insolvent or declares bankruptcy. The joint account may also be subject to a claim under matrimonial law
Tax Implications – Deemed disposition and income tax consequences
There are tax implications to consider as well. The tax implications of setting up joint accounts differ depending on whether the joint owner is a spouse or an adult child.
Under the Income Tax Act, a ‘disposition’ occurs when there has been a change in ‘beneficial’ ownership of an asset. This means that when an adult child is added to an investment account or cottage, for example, capital gains tax may be triggered and payable by the parent.
If a joint account is set up with a spouse, the tax consequences of a deemed disposition can be avoided because federal tax laws permit property to be transferred between spouses at the adjusted cost base (instead of fair market value). As such, tax on the appreciated value of the asset can be deferred until the asset is actually sold. Then there is the question of who is responsible for taxes (income and capital gains) on the asset going forward. Where legal owners have beneficial ownership, each joint account holder is equally responsible for the tax liability and each owner should report earnings based on their portion of ownership. Where the joint owners are spouses, income attribution rules may also apply.
In addition to the income tax and other potential implications or pitfalls, looms the larger issue of whether probate can in fact be avoided. While the legal arguments are complex, the short answers to this question are
“maybe” and “it depends”. Generally speaking, where the joint owners are spouses, the asset will flow to the survivor by right of survivorship outside of the estate and probate fees will not apply. This is not necessarily true where the surviving joint owner(s) is an adult child of the deceased. In that case, the surviving owner may be deemed to be holding the asset in trust for the deceased’s estate. If so, the asset will be subject to the probate process.
Holding assets jointly with rights of survivorship can be convenient and practical and offer savings in time and money when administering a joint owner’s estate. This method of ownership is often recommended for spouses in a first marriage situation where creditors are not an issue. However, there are a number of factors both income tax and non-income tax related that should be considered before taking this step – especially when the intended joint owner is an adult child. The issues include: loss of control, exposure to creditors and unintended tax consequences. The fact that the technique does not ensure avoidance of probate fees means that in many cases, the costs greatly outweigh the benefits.