Unmarried couples have unique financial planning considerations because the rules involving retirement, insurance, income taxes, and estate taxes differ from those that apply to married couples.
Fortunately, planning strategies may be used to deal with varying limitations or exclusions.
- Retirement. Beneficiary designations are critical for unmarried couples because they cannot take advantage of rules governing spousal default on retirement assets. Identifying beneficiaries also allows individuals to avoid the probate process, which typically does not consider unmarried partners as heirs if no will exists.
- Social Security does not provide survivor benefits for unmarried partners. In addition, many defined-benefit pension plans do not provide automatic benefits to a non-spouse partner. These considerations should be taken into account when planning for retirement.
- IRA rules only allow a spousal beneficiary to transfer ownership of an inherited IRA into his or her name. This rule may prevent a non-spouse beneficiary from delaying or reducing required minimum distributions after the death of the account owner and limits the ability of next generation beneficiaries to extend the life of the IRA with a stretch strategy.
- Insurance. Adequate life insurance is critical, especially if one partner is financially dependent on the other. For estate tax purposes, the unlimited marital deduction does not apply to unmarried couples. Still, clients in this category may consider an Irrevocable Life Insurance Trust (ILIT) in order for the beneficiary to avoid estate taxes.
- Health insurance may also present a tax challenge. In some cases, employer-provided health insurance may be taxable if provided to a “non-family” member.
- A partner who loses his or her job may also need to consider that COBRA benefits are only eligible for “qualified” beneficiaries such as the employee’s spouse, former spouse, or dependent child.
- Taxes. There may be disadvantages as well as advantages for unmarried couples when calculating income taxes. There may be issues around which partners can claim certain deductions. But there may also be an opportunity to shift taxable assets to the partner in the lower tax bracket.
- Clients may benefit from creating separate paper trails. For example, separate bank accounts could be established to record each partner’s ‘basis’” for tax purposes.
- Estate planning. There is no unlimited marital deduction for estate tax purposes for unmarried couples.
- Gift taxes may apply. For example, adding a partner to a real estate deed may result in a taxable gift upon the death of the other partner. Also, unmarried couples may not use a split gift strategy.
- Many legal protections and privileges are only available to a surviving spouse. For unmarried couples, the preparation of legal documents, especially those that clearly define asset ownership, are essential. These include, but are not limited to, health care proxy/directives, durable power of attorney, wills, and trusts.
- Couples may choose to set up a revocable trust to be used to transfer assets at death. Simple wills may be challenged by other family members during the probate process.
- Unmarried couples may also want to consider a Domestic Partnership Agreement, which can specify the division of assets in the absence of legal divorce proceedings. Other documents such as Qualified Domestic Relations Orders may be used to split retirement plan assets.