Same-sex couples and heterosexual unmarried couples are increasingly visible, vocal, and currently comprise a large segment of our nation’s population. Meeting their financial needs, as society becomes more complex and people have more personal responsibility for their financial future, can be a boon to producers who sell permanent life insurance.

The U.S. Census Bureau reported in 2000 that only 23% of the nation’s families were traditional mother-father-and-kids units. Most–77% of American households–reported other, non-traditional living arrangements. The U.S. Census Bureau reported over 600,000 households consisting of same-sex couples or unmarried domestic partners. By 2005, the Bureau estimates that figure jumped to over 770,000.

Clearly, many couples, same-sex and heterosexual alike, have resolved to live together without formalizing their relationship through marriage. Despite the growing acceptance of these family structures and lifestyles, they are often not afforded the same privileges as married couples, particularly as regards financial and estate planning.

There are remedies. By planning ahead, same-sex and unmarried couples can protect their assets and employ a tax-efficient transfer of wealth, especially with the help of permanent life insurance policies and the careful creation of an irrevocable trust.

The law and the solution

Respecting taxes assessed at the death of a partner, estate laws favor married couples over all others. Under current statutes, a dying spouse’s wealth and assets may be transferred to a surviving spouse estate tax-free. There is no assessment on the federal or state level.

Same-sex or unmarried couples, however, do not receive the same favorable treatment under the tax code. Essentially, both partners in same-sex and unmarried unions are treated–and taxed–as individuals. Absent careful legal planning, a partner may be no better off than a stranger under the law. Consider the implications for an unmarried couple who fails to draft explicit authorizations to receive information about a partner’s medical conditions under HIPAA or who fails to leave explicit powers under an advance medical directive.

A deceased partner’s assets above the current federal exemption of $2 million are taxed heavily. The federal government can currently take a 45% share of the deceased’s estate, including all property and investments. In addition, many states add on their own levy–as much as 16% above the federal assessment in some cases. Furthermore, while same-sex and unmarried couples can gift assets to one another, the federal government doesn’t waive gift taxes on the transfer, forcing the couple to use annual exclusion gifts or their lifetime exemption to avoid a current gift tax.

A common solution is to create an irrevocable trust that holds permanent life insurance policies benefiting the other partner. Whole life or universal life policies are the preferred funding vehicles for this arrangement. Placing the insurance in the irrevocable trust removes the death benefit from the insured’s estate, thereby reducing the estate value and the estate tax assessment upon the death of one partner.

The insurance will provide liquidity to the surviving partner, an important feature when survivors need to gather up funds to pay for estate taxes on other assets to fund funeral costs and to replace the economic loss suffered from the partner’s death. Under this plan, the trust is equipped with an asset that grows in value over time, and a distribution at the time of one partner’s death that need not be diminished by federal and state death taxes.

With a properly funded permanent life insurance policy, distributions can be made to a partner under circumstances defined in the trust, including those needed to maintain health or provide income under pre-defined conditions. Funding can take place in small, affordable increments over the years, and can be accomplished confidentially.

For professionals such as doctors or lawyers, trusts may be armed with an additional protection from lawsuits, thus keeping assets out of the reach of courts and creditors.

Couples should work out wording and provisions of the trust carefully to ensure the greatest flexibility and maximum comfort for each partner. The trust document will set out how the trust funds will be used for the benefit of the surviving partner and other heirs the parties want to protect. The trust terms should also spell out the disposition of assets should the couple break up.

Flexibility is important for other reasons. Current estate tax rules are a labyrinth of complexity, primarily for political as opposed to practical reasons. The running joke in the estate planning community is that, in addition to meeting with a qualified financial advisor, clients can also help to transfer their wealth tax-efficiently by picking the appropriate year for their demise.

Exemption levels over the next few years are in a state of flux: The current $2 million estate tax exemption rises to $3.5 million in 2009 and is due to be abolished for one year in 2010 (because the federal estate tax will be “abolished” for 2010). However, in 2011 the federal estate tax exemption declines to $1 million. Whether this will all actually happen is a question mark-but it is the way the law is now written.

Same-sex couples who move, perhaps to live in a state with favorable domestic partnership laws, may further complicate their estate taxes. States with favorable domestic partnership laws may not translate to favorable tax treatment under the federal rules.

Bear in mind that many state estate taxes that were once tied to federal rules have been “decoupled” from the federal estate tax, primarily because of negative consequences on state budgets that depend on estate taxes for revenues. A well-constructed trust should take into account the volatility of the federal and state tax rules.

Whole life and universal life

There are instances outside of a trust environment where permanent life insurance is critical to a surviving partner, particularly if an unmarried or same-sex couple relies upon qualified pension plan assets for retirement. While a surviving spouse of a legally married couple can live on the remaining distributions of the plan (under a joint and survivor distribution), under many retirement programs there may be no provision to pay a surviving unmarried or same-sex partner.

A whole or universal life policy can provide a solution by providing capital (or income under a policy’s settlement options) that is sufficient enough to replace the lost pension benefit. Life insurance has numerous other advantages. Because it passes to the named beneficiary by a private contract, it is less likely to be contested by disgruntled family members, as might be the case if assets passed by the public probate procedure.

Serving a broader customer base

The estate planning needs of unmarried and same-sex couples again proves the value of permanent life insurance to adapt to changing times and needs.

Producers who sell permanent life insurance and want to tap into this market should take the time to become acquainted with the unique needs of unmarried heterosexual couples and same-sex partners. Savvy clients will want to work with knowledgeable and trusted financial representatives and lawyers who understand their concerns and can construct a plan that will help them to achieve their goals and secure their families and loved ones.