“Certificates of deposit (CDs) are a low-risk way of putting some money aside for the short- to medium-term future and are a popular way for seniors to earn a modest return on their savings.”
Because of their relative stability, CDs are often included in estates, where they can be passed to heirs in a number of ways. In an effort to avoid the CDs being subject to probate, many people name a TOD, or Transfer on Death beneficiary to their accounts, according to a recent article from Investopedia titled “Are Transfer-on-Death CD Accounts Subject to Estate Taxes?”
The goal is to keep the CD out of probate. However, it doesn’t help when it comes to estate taxes. It may still be a good idea to name a TOD beneficiary on your CD. Here’s why.
When you die, the value of your estate is assessed and may be subject to federal and state estate and/or inheritance taxes. For the federal estate tax to apply, the value of the estate needs to be at a very high level—as of right now. The federal estate tax only applies if the estate is worth $12.06 million or more. Many states no longer have an estate tax, or an inheritance tax, but many still do. The state estate tax exemption limit is considerably lower than the federal threshold—just $1 million in Oregon and Massachusetts
For most people, federal estate tax is not an issue. However, state and inheritance taxes still need to be planned for, so they don’t consume your estate.
There are tax consequences when inheriting a CD. The interest earned by a CD prior to the account owner’s death is not taxable to the beneficiary, and neither is the original amount deposited. However, any interest earned after the original owner’s death is taxable to beneficiaries. If the CD is modest, the taxes will be minimal as well, but there will still be taxes.
What if the CD is a five or six figure CD? There might be a big tax bill due.
This is important to be aware of, since many people incorrectly believe that if they create a TOD CD account, the heir has no tax liability. This is not true. Naming a TOD beneficiary on a CD is a good idea for simplifying the distribution of assets. However, there’s no tax benefit to the heir.
Anyone can be a TOD beneficiary. The TOD beneficiary doesn’t even have to be a person. A charity, business or trust can be a TOD beneficiary. If the TOD is a person, they may be a spouse, child, friend, or anyone you know. If you are married, your spouse may have certain rights to the CD superseding the named TOD beneficiaries. Check with your estate planning attorney, if you are married and want to name someone else as your TOD beneficiary.
Naming a TOD beneficiary to your Certificate of Deposit accounts can help some of your assets avoid probate, a worthwhile goal. The asset will belong to the person faster than if they had to wait for the probate process to be completed. Your estate planning attorney will help identify other assets you can take out of your probate estate and simplify their transfer after death.
Reference: Investopedia (May 23, 2022) “Are Transfer-on-Death CD Accounts Subject to Estate Taxes?”