Financial Plannig Musts for Unmarried Couples

Investment Management and Financial Planning

Unmarried couples are pervasive in our society; they are as vast as widows, never married individuals living together,
divorcees, and same-sex unions. 1 These couples, whether gay or straight, face important issues that their married
counterparts are not exposed to. Unfortunately, many of these issues, if left unattended, can have a dramatic negative
impact on healthcare decisions, income taxes, estate taxes and retirement planning. If you are unmarried and are in a
committed relationship with a life partner, keep reading! You simply cannot afford to ignore the financial and legal
challenges that you and your partner are exposed to.

The U.S. Census Bureau reports that the once dominant “married couple” households have slipped from nearly 80% in
the 1950s to just 50.7% today. Nearly 42% of the U.S. workforce consists of unmarried individuals.   The decision to
not marry can stem from a variety of reasons incluidng the possible loss of deceased or divorced spouse’s benefits 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 forced distributions begins
begin at age 70 ½, for both the account owner and their surviving spouse. That deferral benefit, however, does not
equally apply to a non-spouse benefiary. Here’s how:

For qualified plans (ie. 401k, 403b, unless the proceeds are annualized over the beneficiary’s life starting within one
year of death, they must be included as taxable income within five years of death (a surviving spouse is allowed to defer
proceeds and taxation until age 70 1/2). This shrinks the pot and potential growth of the qualified money for the
surviving partner (assuming the partner is the beneficiary).

IRA accounts offer a little bit more flexibility. Inheriting an IRA from a spouse allows you to put the IRA in your name or
roll over the funds into an IRA you have already set up. The IRS will treat this as if the inherited IRA assets were yours
all along. Conversely, non spouse heirs do not have the option of treating inherited IRAs as your 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 70 ½ or greater (and taking distributions out of the IRA when he/she died), then
you may start taking money out using the same distribution method. If the beneficiary is younger than the decdent, this
option is typically not recommended, unless you desperately need the money since it will accelerate your income and
taxes. The other alternative would be to take the required distributions in annual installments over the beneficiary’s
lifetime, and based on the beneficiary’s life expectancy (not the decedent’s).

If the decedent was not yet taking distributions out of the IRA, you have two IRA distribution options:

•        All of the interest from the IRA must be distributed to you by December 31st of the fifth year after the year the
decedent died, (not the best choice) OR
•        All of the interest must be distributed over your life expectancy (preferable 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. You are encouraged to 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 in order 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 second spouse dies. Unmarried couples do not get to
benefit from this unlimited marital deduction. So, any assets (including home, car, savings, retirement accounts,
collectibles, etc) above $2,000,000 are subject to taxation rates as high as 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 inadvertently get disinherited. Unlike with married couples, surviving
partners do not automatically have a share in the estate.   If you die intestate (without a will), the estate will pass under
state intestate succession laws and the estate assets, including maybe your primary home, will likely be transferred to
the blood relatives (surviving parents, siblings, etc)!

Basic Solutions for Asset Transfers at Death

One of the best ways to ensure an efficient transfer of assets from one unmarried partner to another is through a
combination of wills, will substitutes and trusts. Failure to plan for this is planning to fail.

Wills

The most widely recognized means of transferring wealth at death is by use of a will. Without knowing the details of
exactly what happens, most people know that a will must be presented to the local probate court. If a will does not
properly dispose of a deceased individual’s assets, then the probate court gets involved in distributing that person’s
assets, a process that can be both costly and time consuming.

Will Substitutes

The will substitute has the advantage of avoiding the probate process and the related cost, delay, and potential
publicity. It also has the advantage of allowing the current owner of property to name the person or persons who are to
receive the owner’s interest at his or her death. Will substitutes are revocable and include common forms of ownership
like “joint with rights of survivorship”, beneficiary designations (for retirement accounts), transfer on death clauses (for
investment or brokerage accounts), payable on death clauses (for bank accounts) and revocable living trusts. It is
always best to consult with a qualified professional for any gift or tax consequences that these strategies may cause.

Living Trusts

A revocable living trust is almost always established for two reasons: (1) to avoid probate; and (2) to handle the grantor’
s financial affairs in the event of the grantor’s incapacitation.   Since such a trust cannot accomplish any tax objectives
and provides no asset protection, income from the trust assets is taxed to the grantor under the grantor trust rules. No
gift tax is due upon funding the trust because the retained right to revoke prevents a completed gift. Likewise, the
retained right to revoke also means that the trust assets are included in the grantor’s gross estate.

Life Insurance Trusts

A life insurance policy for the benefit of a surviving partner can help supplement future income lost from forced
distribution from a qualified plan, the inability to receive spousal social security benefits and pension survivor benefits.

Furthermore, using an irrevocable life insurance trust (ILIT) can remove the life insurance policy out of 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 liquidity necessary to help pay estate tax and settlement costs incurred by the deceased
partner’s estate.

Healthcare Planning Necessities

Finally, non-spouses, in the event of disability or incapacitation, do not have automatic rights to the care and finances of
the disabled partner. The following are some of the “must haves” in order to ensure that you and your partner can
make medical and financial decisions for one another.

Living Will

A living will stipulates what life-saving medical procedures you want or don't want in the event you are 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 must be memorialized in a legal
document. Otherwise, your partner’s wishes may be overwritten by his or her family, since you are not legally related to
your partner.

Medical Power of Attorney

A medical power of attorney appoints a person the power to make medical decisions on your behalf. What are the
consequences of not having this document? Let’s say that your partner of ten years is hospitalized, as a “non family”
member you may be prohibited from visiting your partner or discussion your partners medical condition with his/her
healthcare professional. Instead, an immediate family member like a parent or sibling may be the only ones privy to
discussing medical information with your doctors—not your partner.

Financial Power of Attorney

A financial power of attorney states 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 are disabled. Both must work alongside one
another to ensure that you and your partner are cared for, both physically and financially.

In summary, estate planning can be a very tedious and complex process, but it must be done—married or not.
Although unmarried couples clearly face challenges that married couples do not, they are challenges that can
effectively be overcome with some careful planning. I highly recommend that anyone considering an estate plan seeks
the counsel of a competent and experienced legal professional.

**Disclaimer: initially published in 2007, tax rates and rules may have changed since then.

Financial Planning Musts for Unmarried Couples
by Cathy Pareto, MBA, CFP®, AIF®, December 2007*

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