How Does Estate Planning Differ for Same-Sex Couples

May 19, 2012
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Same-sex couples and same-sex marriages face important issues that traditional married couples are not exposed to. Because gay marriage is not recognized in the majority of states and certainly not at the federal level, estate planning for same-sex couples is an absolute necessity. Unfortunately, many of these issues, if left unattended, can have a dramatic negative impact on healthcare decisions, income taxes, estate taxes and retirement planning.  Same-sex couples cannot afford to ignore the financial and legal challenges that you and your partner are exposed to.

Retirement Benefits

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.

Also, prior to the passing of the Pension Protection Act of 2006, beneficiaries of 401k plans other than spouses typically had to take lump-sum payments from the plan, versus say doing a rollover into an IRA.  Income taxes would have to be paid immediately on the lump-sum.  But, effective 1/1/07, all non spouse beneficiaries can now transfer the 401k proceeds into an Inherited IRA and withdraw the funds over their own life expectancy (thereby minimizing immediate tax impact and allowing account to grow well into the future).  However, it should be noted that for “traditional married couples” the surviving spouse is able to convert the entire plan into their own IRA (not subject to minimum distributions until the surviving spouse turns 70 1/2).  You see, there is still a unfair “penalty” for same-sex couples in this scenario who may wish to defer taxes as long as possible, like traditional married couples.

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 $5,000,000 (as of 2012) are subject to taxation rates as high as 35%.

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.

Health-care 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.

Cohabitation Agreements

A cohabitation agreement is a great tool for unmarried and same-sex couples to establish legal rights and responsibilities with respect to their relationship.

In summary, estate planning can be a very tedious and complex process, but it must be done—married or not.  Although same-sex couples clearly face challenges that traditional married couples do not, they are challenges that can effectively be overcome with some careful planning.  I highly recommended than anyone preparing an estate plan seeks the counsel of a competent and experienced legal professional that specializes in these specific issues.

***Update: On June 26, 2015 the U.S. Supreme Court’s decision overturning same-sex marriage ban changed the entire landscape for planning for same gender couples.  

Additional Resources:

Lamda Legal – Tax Considerations for Same-Sex Couples

Journal of Accountancy – Tax Issues Present Challenges and Opportunities