In the past, financial planning for unmarried couples has largely focused on LGBT couples. The decision in Obergefell v. Hodges allowed same-sex couples to have their marriages recognized by the states, but advisors may find some of their clients, gay or straight, prefer to stay unmarried for various reasons.
Obergefell is important because it “highlights the differences between married couples and unmarried couples” in financial planning, according to Wendy Goffe, a partner at law firm Stoel Rives in Seattle.
Goffe spoke on a webinar presented by the Investment Management Consultants Association in April about the many challenges that unmarried couples face in financial planning.
“Planning for unmarried couples is only a special application of the general estate planning principles,” she said, however, they “often require a more individualized and resourceful approach to their estate planning.”
Why Not Marry?
“Even though same-sex couples can marry, they may choose not to marry, as may opposite-sex couples,” Goffe said.
Clients may decide to stay unmarried to avoid income tax burdens, or liability for back taxes and penalties on one partner, Goffe noted.
Married couples filing jointly can use capital losses to offset ordinary income only up to $3,000, or $1,500 if they’re filing separately, while single people can offset up to $6,000.
Unmarried couples may also be able to pay lower combined income taxes by having one partner file as head of household and the other file as an unmarried taxpayer, Goffe suggested.
For couples who want to marry but can't, there are ways to get some of the benefits available to legally married couples. Some states provide limited rights and responsibilities under civil union, domestic partnership or common law marriages, Goffe said, while others provide an everything-but-marriage statute.
There are less common ways for unmarried clients to form partnerships, too. Hawaii and Colorado allow couples to register as “reciprocal” or “designated” beneficiaries, respectively, with limited rights similar to those extended to married couples.
Common law marriage statutes may apply to clients even if they don't realize it, Goffe said. She noted standards for establishing a common law marriage include an “intent and express mutual agreement” between both partners; the capacity to make such an agreement; cohabitation, although in some states that may only require an exclusive relationship; and “the parties must hold themselves out as married.”
Goffe said that even though “some states still refuse to give full faith and credit to common law marriages,” if the common law marriage is formed in a state that recognizes it, it is recognized for federal purposes as well. There's no common law divorce, though. Couples need to go through a legal dissolution to end the partnership, Goffe said.
Terminating a civil union or domestic partnership may be difficult. Unmarried couples who part ways may not be eligible for federal tax exemptions when dividing property. There's also no deduction for alimony or separate maintenance payments for unmarried couples.
“The Internal Revenue Code essentially treats unmarried couples as legal strangers,” Goffe said.
Even in cases where couples have a legal partnership, they may not be eligible for certain benefits. For example, transfers between unmarried spouses may be treated as taxable gifts, even though a domestic partnership or civil union gives partners a legal obligation to support each other, Goffe said.
“We have a conflict between the gift and estate tax laws and the obligation of support,” Goffe explained. “Technically, we assume that if there is a legal obligation of support, that it's only the amounts that are transferred over the amount necessary to [provide] support that would be treated as a taxable gift.”
However, if clients share assets and one earns more than the other, they could inadvertently trigger the transfer of wealth tax, she said.
Although spouses are considered members of the same generation, unmarried couples with a significant age gap between partners — 37.5 years — may also trigger the generation skipping tax, Goffe said.
“This only becomes a problem if the transfer is greater than their generation skipping transfer tax exemption.”
Joint tenancies are “very convenient” for unmarried couples because when one partner dies, property ownership transfers to the survivor. However, if each partner doesn't contribute equally to assets held in the joint tenancy, it could trigger a gift tax. Furthermore, when one partner to a joint tenancy dies, the survivor will be treated as having owned 100% of that property unless they can prove otherwise “with clear and convincing evidence.”
“This isn't a problem unless there's a taxable estate,” Goffe said, “but if there is a taxable estate, […] it is important to either contribute jointly and have good documentation, or to have good documentation and have the account refunded so you don't inadvertently create multiple layers of tax.”
Employee Benefits, ERISA Rules
Some employers may extend benefits to unmarried employees’ partners in domestic partnerships or civil unions. Unlike married couples, though, the benefits can be counted in taxable income, Goffe said. Furthermore, employees can't use pretax dollars to pay for a domestic partner's coverage, or use HSA and FSA funds to pay for a domestic partner's medical expenses unless that person is a dependent.
“ERISA generally does not recognize an unmarried partner as entitled to benefits the way [it] would a spouse,” Goffe said.
As of 2008, non-spouses are allowed to roll assets inherited from a qualified retirement plan into an inherited IRA on a tax-free basis, Goffe said, including some 403(b) and 457 plans.
A qualified domestic relations order is a court order to split retirement plan assets between partners, but it doesn't apply to unmarried partners.
“There are some very limited exceptions to that for an alternate payee, but other than that, it's not clear whether a plan can be amended to recognize any sort of order outside of marriage,” Goffe said.
Continuation health coverage under COBRA does not extend to an unmarried partner, though it does cover dependent children, Goffe said. Some state COBRA plans may offer broader coverage.
Social Security recognizes unmarried couples as individuals, rather than couples, Goffe said. A person may inherit benefits from their partner if the state they live in recognizes them as a couple.
Regarding unmarried veterans, “some inroads have been made to find certain benefits not subject to marriage requirements,” Goffe said, including “the transfer of post 9/11 GI Bill education benefits to dependents, participation in various group life insurance programs for veterans, and survivor and dependent education assistance.”
“Granted these are very narrow benefits, but better than nothing,” she said.
She added that in some cases, the secretary of the Veterans Administration may allow people in “committed relationships” with servicemembers to be buried in a VA cemetery.
Servicemembers who received a dishonorable discharge for violating the Don't Ask Don't Tell policy may apply for an upgrade to their discharge papers, Goffe said.
“Many of our unmarried clients were discharged for violating Don't Ask Don't Tell and otherwise had a very good service record. This can be turned around,” she said.
Ultimately, “nobody should rely on default statutes,” Goffe warned, as “responsibility or the right to inherit may fall to their sibling, their children, their parents, but not their partner.”
Goffe recommends that advisors take into account the possibility that their unmarried clients may decide to get married later when they’re drafting wills and other agreements.
“It's a couple of extra sentences in a will, and it makes all the difference in avoiding tax on the transfer from one spouse to the other,” she said.
She also warned that advisors take care to define terms like “partner” in documentation to make sure that they apply to the person they’re meant to. For example, if “partner” is defined in a will as “the person living with me at the time of my death,” but the client dies in an assisted living facility or nursing home, they may run into trouble.