Unmarried couples are ubiquitous in our society; they are as big as widows, people who have never married and live together, divorcees and same-sex unions. These couples, whether gay or straight, face significant issues that their married counterparts do not. Unfortunately, many of these issues, if left unaddressed, can have a dramatic negative impact on health care decisions, income taxes, estate taxes, and retirement planning. If you’re not married and in a committed relationship with a life partner, read on! You simply cannot afford to ignore the financial and legal challenges you and your partner are exposed to.
The US Census Bureau reports that once-dominant “married couple” households have shrunk from nearly 80% in the 1950s to just 50.7% today. Nearly 42% of the US workforce consists of single people. The decision not to marry can be for a variety of reasons, including the possible loss of benefits of the deceased or divorced spouse to impenetrable legal barriers for same-sex couples. In fact, many widows and divorcees, despite having found love again, cannot afford to remarry for fear of losing health, pension, or social security benefits.
real world challenges
retirement benefits
One of the benefits of a qualified retirement plan is the ability to defer income taxes until mandatory distributions begin at age 70½, for both the account owner and their surviving spouse. That deferred benefit, however, does not apply equally to a non-spouse beneficiary. That is how:
For qualified plans (i.e., 401k, 403b), unless earnings are annualized over the lifetime of the beneficiary beginning one year after death, they must be included as taxable income within five years of death ( a surviving spouse can defer income and taxes until age 70 1/2). This reduces the pot and potential growth of qualifying money for the surviving member (assuming the member is the beneficiary).
IRA accounts offer a little more flexibility. Inheriting an IRA from a spouse allows you to put the IRA in your name or transfer the funds to an IRA you’ve already established. The IRS will treat this as if the inherited IRA assets were yours all along. In contrast, non-spouse heirs do not have the option of treating inherited IRAs as their own. This does not imply that the money is not yours; it simply means that you cannot make any contributions to that IRA or roll it over to another IRA. If the decedent was age 70½ or older (and was taking distributions from the IRA when he/she died), then
you can start withdrawing money using the same distribution method. If the beneficiary is younger than the decedent, this option is generally not recommended, unless he desperately needs the money, as it will speed up his income and taxes. The other alternative would be to take the required distributions in annual installments over the life of the beneficiary and based on the life expectancy of the beneficiary (not that of the decedent).
If the decedent was not already taking distributions from the IRA, you have two distribution options from the IRA:
o All IRA interest must be distributed to you by December 31 of the fifth year after the year the decedent died (not the best choice) OR
o All interest must be spread over your life expectancy (preferred option)
Government and corporate pensions are the least flexible of all. In an employer-sponsored pension plan, the surviving partner may not be entitled to any survivor benefits. We recommend that you confirm whether or not this is available with your HR manager. Social Security spousal benefits are simply not available to non-spouses, period. The consequence is that your partner will be forced to accumulate more funds to ensure a comfortable retirement after you are gone.
Taxes
Unmarried couples are also negatively affected with respect to estate taxes. There is a special provision in the tax law that allows married couples to defer estate taxes until after the death of the second spouse. Unmarried couples do not benefit from this unlimited marital deduction. Therefore, any assets (including home, car, savings, retirement accounts, collectibles, etc.) over $2,000,000 are subject to tax rates of up to 47%.
Asset Transfers
As an unmarried couple, dying without a will and other related estate planning documents is a recipe for disaster. Without a clearly defined will, your partner may be inadvertently disinherited. Unlike married couples, surviving partners do not automatically have an interest in the estate. If you die intestate (without a will), the estate will pass under state intestate succession laws and the assets of the estate, including perhaps your main home, will likely pass to blood relatives (surviving parents, siblings, etc.)!
Basic Solutions for Asset Transfers on Death
One of the best ways to ensure an efficient transfer of assets from one unmarried couple to another is through a combination of wills, will substitutes, and trusts. Failing to plan for this is planning to fail.
wills
The most widely recognized means of transferring wealth at death is through the use of a will. Without knowing the details of exactly what is going on, most people know that a will must be filed with the local probate court. If a will does not properly dispose of a deceased person’s assets, then the probate court becomes involved in the distribution of that person’s assets, a process that can be costly and time consuming.
will substitutes
The will substitute has the advantage of avoiding the probate process and the associated cost, delay, and potential publicity. It also has the advantage of allowing the current owner of the property to name the person or persons who will receive the owner’s interest upon the owner’s death. Will substitutes are revocable and include common forms of ownership such as “joint with rights of survivorship”, beneficiary designations (for retirement accounts), transfer-on-death clauses (for investment or brokerage accounts), payable clauses on death (for bank accounts) and revocable living trust clauses. It is always best to consult with a qualified professional about any gift or tax consequences these strategies may cause.
living trusts
A revocable living trust is almost always established for two reasons: (1) to avoid probate; and (2) to manage the grantor’s financial affairs in the event of the grantor’s incapacity. Since such a trust cannot accomplish any tax purposes and does not provide asset protection, income from the trust assets is taxed to the grantor under the rules of the grantor’s trust. No gift tax is due when funding the trust because the revocation lien prevents a gift from being completed. Likewise, the retained right of revocation also means that the assets of the trust are included in the gross estate of the settlor.
life insurance trusts
A life insurance policy for the benefit of a surviving spouse can help supplement future income lost from forced distribution from a qualified plan, inability to receive spousal social security benefits, and survivors’ pension benefits.
Additionally, the use of an irrevocable life insurance trust (ILIT) can remove the life insurance policy from the estate. You must make sure that you do not own the policy when you die. The proceeds can go to the same beneficiary but the policy must be owned by the trust. If a policy is transferred, the transfer must take place within three years of death. An ILIT can also help provide the necessary liquidity to help pay for estate tax and settlement costs incurred by the deceased partner’s estate.
Health Planning Needs
Finally, non-spouses, in case of invalidity or incapacitation, do not have automatic rights to the care and economy of the incapacitated spouse. The following are some of the “must haves” to ensure that you and your partner can make medical and financial decisions for each other.
Living will
A living will stipulates what life-saving medical procedures you do or do not want in the event you become physically or mentally incapacitated. The Terry Schiavo case shed important light on this controversial issue. If you and your partner have an understanding of what your end-of-life medical planning should be, it should be in a legal document. Otherwise, your partner’s wishes may be overridden by your family, since you are not legally related to your partner.
medical power of attorney
A medical power of attorney designates a person with the power to make medical decisions on your behalf. What are the consequences of not having this document? Suppose your partner of ten years is hospitalized, as a “non-relative” remember that you may be prohibited from visiting your partner or discussing your partner’s medical condition with your healthcare professional. Instead, an immediate family member, such as a parent or sibling, may be the only one private to discuss medical information with their doctors, not her partner.
financial power of attorney
A financial power of attorney establishes who can make financial decisions on your behalf. A medical power of attorney does not dictate who and how your finances will be handled in the event you become disabled. You both need to work together to make sure that you and your partner are well taken care of, both physically and financially.
In short, estate planning can be a very tedious and complex process, but it has to be done whether you are married or not. Although unmarried couples clearly face challenges that married couples do not, they are challenges that can be effectively overcome with careful planning. I highly recommend that anyone preparing an estate plan
seek the advice of a competent and experienced legal professional.