If you’re a California resident managing assets or planning your estate, you may have heard about transfer-on-death (TOD) accounts as a way to avoid probate. While TOD accounts can simplify the transfer process when you pass away, many families don’t realize these accounts come with significant tax implications that can affect your beneficiaries and overall estate plan.
This guide explains how TOD accounts work, what taxes apply, and whether this strategy is right for your family’s needs.
## What Are Transfer-on-Death Accounts and How Do They Work?
Transfer-on-death accounts are estate planning tools that allow your assets—such as bank accounts, brokerage accounts, or investment portfolios—to pass directly to named beneficiaries without going through probate court. This means your loved ones can access these funds more quickly after your death.
During your lifetime, you maintain complete control over TOD accounts. You can manage investments, make withdrawals, add funds, or even close the account entirely. The beneficiary designation only takes effect upon your death.
## Do Transfer-on-Death Accounts Avoid Taxes?
Here’s what many California families don’t realize: while TOD accounts avoid probate, they don’t eliminate tax obligations. Your estate and beneficiaries may still face several types of taxes:
### Federal and State Estate Taxes
The IRS imposes estate tax on the total value of your estate at death. For 2023, the federal estate tax exemption is $12.92 million. If your estate is valued below this threshold, no federal estate tax is owed.
However, TOD accounts are still part of your taxable estate—they don’t reduce estate tax liability. California doesn’t impose a state estate tax, but if you own property in other states, those states’ estate taxes may apply.
### Income Taxes During Your Lifetime
While you’re alive, you’re responsible for paying federal and California state income taxes on any interest, dividends, or other income generated by your TOD accounts. This is because you retain full ownership and control of these assets.
### Inheritance Taxes for Beneficiaries
Unlike estate taxes (paid by your estate), inheritance taxes are paid by beneficiaries who receive assets. Fortunately, California does not impose an inheritance tax. However, only a handful of states still collect this tax, and the amount owed often depends on the beneficiary’s relationship to you.
## Who Pays Estate Taxes When TOD Accounts Are Involved?
This is a critical question for California families: after your death, your estate administrator must file final tax returns and pay all taxes before distributing assets to beneficiaries. These taxes can include:
If your estate doesn’t have sufficient funds to cover tax bills, California state law may require TOD account beneficiaries to contribute toward paying estate or inheritance taxes. Some states even allow you to include instructions in your will or trust requiring beneficiaries to cover tax liabilities.
## The Capital Gains Tax Advantage: How TOD Accounts Can Save Your Family Money
Here’s where TOD accounts offer a significant benefit for California families: the step-up in basis rule for capital gains taxes.
When you sell appreciated investments during your lifetime, you owe capital gains tax on the profit (the difference between the sale price and your original purchase price). However, when assets transfer through a TOD account at your death, beneficiaries receive a “step-up in basis”—meaning their tax basis becomes the asset’s value on your date of death.
Real-World Example:
Imagine you purchased 1,000 shares of stock for $10 each ($10,000 total). Years later, the stock value increases to $75 per share ($75,000 total). If you sold the stock while alive, you’d owe capital gains tax on $65,000 in profit. However, if these shares transfer through a TOD account, your beneficiaries inherit the stock at its $75 per share value. If they sell immediately at that price, they owe no capital gains tax.
This step-up in basis can save California families tens of thousands of dollars in taxes.
## Should California Families Use TOD Accounts or Other Estate Planning Strategies?
TOD accounts work well for some families but aren’t always the optimal strategy. Here are alternative approaches California residents should consider:
### Lifetime Gifting to Reduce Your Taxable Estate
Gifting assets during your lifetime can remove them from your taxable estate. As of 2023, you can give up to $17,000 per person per year without triggering gift tax. These gifts are tax-free for both you and the recipient.
Married couples can double this amount—together, you and your spouse can give up to $34,000 per recipient per year. This strategy is particularly effective for high-net-worth California families approaching the federal estate tax exemption threshold.
### Beneficiary Designations for Multiple Account Types
Beyond TOD accounts, you can add beneficiary designations to:
These designations allow assets to pass directly to beneficiaries without probate, but as with TOD accounts, you must carefully consider tax consequences.
Transfer-on-Death Deeds for California Real Estate
California allows transfer-on-death deeds for real property, enabling you to name a beneficiary who becomes the owner after your death. This avoids probate for real estate while potentially providing the same capital gains tax benefits as TOD accounts.
## How California Probate and Trust, PC Can Help You Navigate TOD Accounts and Estate Planning
At California Probate and Trust, PC, we understand that California families need more than just legal documents—you need a comprehensive strategy that protects your assets, minimizes tax liability, and ensures your wishes are honored.
Our experienced Sacramento-based attorneys specialize in helping California residents:
We’ve helped thousands of California families develop estate plans that balance probate avoidance, tax efficiency, and family protection. Our transparent pricing and compassionate approach mean you’ll never feel pressured or confused about your options.
## Take the Next Step: Schedule Your Free Consultation
Don’t leave your family’s financial future to chance. Before setting up TOD accounts or making other estate planning decisions, talk to an experienced California estate planning attorney who can evaluate your complete financial picture.
California Probate and Trust, PC offers free one-hour consultations where we’ll review your family dynamics, discuss your goals, and recommend the most effective strategies for your situation.
Contact us today:
With offices in Fair Oaks, Sacramento, and San Francisco, we’re here to serve California families throughout the state.
## Legal Disclaimer
This article provides general information about transfer-on-death accounts and estate planning under California and federal law. It is not legal advice and does not create an attorney-client relationship. Estate planning and tax laws are complex and subject to change. Tax exemption amounts, rates, and rules may differ from those stated here due to legislative updates. Your specific situation may involve unique considerations that require personalized legal guidance. Before making any estate planning decisions, including establishing TOD accounts or implementing gifting strategies, consult with a qualified California estate planning attorney who can evaluate your individual circumstances and provide advice tailored to your needs.
Source: Transfer-on-Death Tax Implications (FindLaw)