Brokerage accounts give investors access to a wide range of securities. This chapter covers the main account registrations eligible for trading, including:
Toward the end of the chapter, you’ll also see common account features that can be added to these registrations.
When you open a cash or margin account at a financial firm, you must choose an account registration. The registration depends on factors such as who owns the account and how the account is taxed.
An individual account is owned by one person. An individual account can also be registered as transfer on death (TOD), meaning the account has a named beneficiary. When a brokerage account has a beneficiary, the account generally avoids probate and passes directly to the beneficiary.
Probate court is the legal process used to distribute assets after someone dies. If an account has no beneficiary, it’s handled through probate. Whether the decedent (the deceased person) had a will or not, the court oversees how the estate is administered and how assets are distributed. Probate can be time-consuming and complex, which is why many investors try to avoid it. TOD accounts typically aren’t subject to probate and usually require only a death certificate for the beneficiary to claim the account.
If an individual account does not have a TOD designation, it becomes part of the estate and is handled through probate. To claim the account, the executor or administrator of the estate must provide court documents showing they have authority to act on behalf of the estate. This person is responsible for paying the decedent’s debts and distributing the remaining assets.
Even if someone is named as executor in a will, the probate court must officially appoint them. After the executor receives the court appointment document, they submit it to the financial firm to gain control of the decedent’s account. The executor then follows the court process to distribute assets to the estate’s beneficiaries.
Accounts with more than one owner are joint accounts. There are two primary types of joint accounts: with rights of survivorship and tenants in common.
Joint with rights of survivorship (WROS) accounts give equal ownership rights to all owners. If one owner dies, the surviving owner(s) automatically own the account. For example, assume John and Stacey own a joint WROS account. If John dies, Stacey becomes the sole owner. As long as at least one owner survives, joint WROS accounts avoid probate.
Joint WROS accounts may also include a transfer on death (TOD) designation. In a joint account, TOD matters only if all owners die. If that happens, the assets pass to the named beneficiaries.
Community property with right of survivorship (CPWROS) is a form of joint ownership available only to married couples, and only in certain community property states such as California, Texas, and Arizona. In these states, property acquired during marriage is generally considered equally owned by both spouses. CPWROS combines community property rules with survivorship. Regardless of whose name is on the title, assets acquired during marriage are treated as jointly owned. When one spouse dies, the right of survivorship allows the deceased spouse’s share to pass automatically to the surviving spouse, avoiding probate. Additionally, CPWROS does not allow the assets to be passed to heirs through a will.
Joint accounts can also be registered as tenants in common (TIC). TIC accounts assign specific ownership percentages to each owner. If one owner dies, that owner’s percentage becomes part of their estate and goes through probate. For example, assume Jim owns 40% of a TIC account and Jada owns 60%. If Jada dies, her 60% becomes property of her estate and is handled in probate. Jim keeps his 40% and moves it into an individual account in his name.
While all owners are alive, WROS and TIC accounts function similarly in day-to-day operations. Even if there are many owners, any one owner can submit trading instructions, receive mail, manage the account, and request withdrawals without the permission of the other owners. However, any check issued from the account must include all owners’ names, regardless of who requested the check.
The next few account types are fiduciary accounts. A fiduciary is a third party who oversees another person’s assets. Fiduciaries must put the client’s interests ahead of their own and act in the client’s best interest. All accounts in this section share that core feature.
Fiduciary accounts are governed by the Uniform Prudent Investor Act (UPIA). UPIA requires fiduciaries to invest with a holistic (big-picture) view of the portfolio. For example, if you’re managing assets for a risk-averse investor, the portfolio might still include a few aggressive investments as long as the overall portfolio remains conservative. Under UPIA, fiduciary performance is evaluated based on the portfolio as a whole, not on one or two individual positions.
UPIA also explicitly emphasizes diversification. Diversification means spreading investments across multiple asset classes (e.g., stocks, bonds, real estate) and across multiple securities. This helps reduce non-systematic risk, which is risk tied to a specific company, industry, or narrow segment of the market.
We’ll discuss these fiduciary registrations in this section:
A discretionary account gives a financial professional trading authority over an account. If you don’t have the time or knowledge to manage your own brokerage account, you can grant your broker power of attorney (POA), which allows them to make investment decisions on your behalf. When a firm has POA over a customer’s account, it can place trades without getting prior approval for each transaction.
To make suitable decisions, the firm must have enough information to understand the customer’s situation. Customers are asked suitability questions, and some items in a client’s suitability profile (such as net worth and annual income) are voluntary to answer. However, if the customer does not provide the information, the firm cannot make recommendations. The same limitation applies to discretionary accounts.
Discretionary accounts require additional supervision because of the authority granted to the financial professional. Trades placed for customers under POA must be marked as “discretionary” and reviewed more frequently by principals (supervisors). Discretionary trades must be reviewed promptly after submission.
A discretionary order is one where the financial professional makes a decision for the customer about any of the following:
Asset: what security is being bought or sold
Action: if the security is being bought or sold
Amount: how many shares or units are being bought or sold
Many people remember this as the “AAA” rule. If the financial professional chooses the asset, action, or amount, the order is discretionary and requires POA.
In some cases, a financial professional can make limited decisions without the order being treated as discretionary. The following may be decided without POA or discretionary status:
Price of the security
Time of the trade
Even then, the trade must be completed within one day to remain non-discretionary. If it takes longer than one day, the order becomes discretionary and requires POA.
Discretionary accounts are often marketed as “wrap” accounts. These accounts bundle services - typically investment management and account maintenance - into a single fee. Instead of paying separate commissions and service charges, the customer pays one “wrapped” fee.
Wrap account fees are usually charged as an assets under management (AUM) fee. For example, a customer with a $100,000 account would pay $1,000 per year if the wrap fee is 1% of AUM.
Wrap accounts are investment advisory products. Financial professionals must be properly licensed as investment adviser representatives (IAR) to sell them. Passing this exam (along with the SIE and Series 7) allows you to register as an IAR.
Custodial accounts are opened for minors under age 18. A custodian opens the account and manages the assets for the minor, but the assets belong to the minor. Custodians are often parents, but they can be anyone. Each custodial account allows only one custodian and one minor.
To open a custodial account for a child, you generally need the child’s social security number (SSN), because taxes are reported under the minor’s SSN. Reporting under the minor’s SSN can be beneficial because minors often have little or no taxable income.
The two types of custodial accounts are UGMA (Uniform Gifts to Minors Act) and UTMA (Uniform Transfer to Minors Act), named after the laws that created them. UGMA accounts require the custodian to transfer control of the assets to the minor at the age of majority (usually 18 or 21, depending on the state). UTMA accounts were created later and allow the custodian to delay the transfer (up to age 25, depending on the state).
In addition to acting in the minor’s best interest, custodians must avoid certain aggressive strategies in UGMA and UTMA accounts. Specifically, short sales, margin, and option strategies involving unlimited risk (naked options and covered puts) are prohibited due to the risk involved.
All gifts to a minor’s custodial account are irrevocable, meaning they can’t be taken back. The custodian may withdraw funds only to pay for items that directly benefit the child*, or the custodian may leave the assets in the account until they must be turned over at adulthood. The assets also can’t be transferred to a different beneficiary. Once a contribution is made, it becomes the minor’s property.
*Withdrawals from custodial accounts may not be used for essential living expenses, which include food, clothing, and shelter. However, they may be spent on non-essential items that will directly benefit the child, including the cost of summer camp, a computer, a car, education expenses, etc.
If someone cannot manage their own finances, a court may appoint a guardian to oversee that person’s assets. Often this involves mental incapacitation or an inability to manage money. Guardianship accounts are opened when the financial firm receives the required court appointment documents. The person’s assets are then placed into a guardianship account and may be managed only by the court-appointed guardian.
Similar to custodial accounts, guardianship accounts must avoid risky strategies involving short sales, margin, and option strategies with unlimited risk potential.
Now that you’ve seen the main account registrations, let’s look at account features that can be added.
Investment accounts can include features such as check writing, option trading abilities, margin, and cash management. The main feature covered here is trading authorization. If an account owner wants to give a third party authority to act on their behalf, they can grant a power of attorney (POA).
Limited POA allows the third party to place account transactions, including buying and selling securities, but it does not allow withdrawals. Full POA allows the third party to buy and sell securities and request withdrawals.
If the POA is non-durable, it ends if the account owner becomes incapacitated. Incapacitation can include a medical coma or mental incompetency. Durable POA remains in effect even if the account owner becomes incapacitated.
POA always ends when the account owner dies. At that point, control of the decedent’s assets passes to the executor or administrator of the estate. POA can also be revoked at any time by the account owner.
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