August 2, 2012

Child's Bank Account

Many people, armed with good intentions, often add their child to their bank account. As said by a relative of mine, "mom just wanted to make sure that if something happened to her, we would have access to her account to pay her bills." 

This type of do-it-yourself estate planning is ill-advised for at least 3 reasons:

1. Creditor attachment

If the child were to have a judgment rendered against them, the bank account may be subject to levy, i.e. they take your money away. While the probate code says that the ownership interests in a joint tenancy bank are initially allocated in proportion to contribution, whereby the parent can argue that the child supplied no funds. Prob C § 5301. The parent will nonetheless have to prove that the child supplied nothing to account. Thus, the parent might have to hire legal counsel to show that all funds can be traced to them instead of the child to avoid attachment.

2. No duty to account

In a curious court ruling, Lee v. Yang (2003) 111 CA4th 481, the court held that an account owner who withdraws more than that owner's share of account contributions has no duty to account to the other owner. Thus the child could virtually drain the account of everything and not have to account to the parent. Of note, a current bill in the California legislature would reverse this court ruling. Still, for the time being, the child could freely withdraw the entire balance of the account and not have to reimburse the parent for the withdrawn funds.

3. Gift taxes

Each person is allowed to gift to another, subject to limited exceptions, $13,000 per year. If you have a bank account worth $50,000 for instance and you add your child's name to the account, you arguably have gifted more than the allotted $13,000 to the child because the child may withdrawal the entire balance. In turn, you have to file a gift tax return, IRS Form 709, or pay the gift tax. Either way, a gift tax return will have to be filed. 

What can a parent do then?

For starters, a parent should not add their child's name to the account. 

The ideal solution is to transfer the account into a trust.  If the parent ever becomes incapacitated, the child can become the trustee and manage the account on behalf of the parent subject to various fiduciary duties. These duties are not imposed on the child when they are simply a co-owner of the account.

An alternative is to name the child the pay-on-death beneficiary. When the parent passes away, the child will merely have to show the bank (1) a death certificate and (2) some form of identification, e.g. a driver's license, to inherit it. The one drawback with a P.O.D. is that the child could not access the funds while the parent is alive. A P.O.D. is only effective at death. Hence, if the parent ever becomes incapacitated, the child could not gain access to the funds at that point unlike a trust.