Financial Planning For Unmarried Domestic Partners

How times have changed. Less than 22 percent of American households are composed of married couples with dependent children, according to the latest U.S. Census. That number has dropped significantly: In 1970, 40 percent of households fit in that category.(1) Meanwhile, over the past 40 years, the number of unmarried couple households has tripled to nearly four percent of the population; there are currently about four million such households in the United States.(1)

Legal Protections

Unlike married couples, unmarried partners lack many of the legal protections or rights granted to spouses in the event of divorce or death. Although most states will consider a claim by an unmarried partner, there is no specific legal precedent in the absence of a written contract. Therefore, couples may wish to consider creating a domestic partnership agreement. This document can detail the sharing of expenses as well as the ownership and distribution of assets should the relationship end. A domestic partnership agreement is especially important in situations where one partner is the primary breadwinner or owns the majority of assets.

Decision-making control is another crucial issue. Unmarried partners should create durable power of attorney and health care proxy documents. Some states also require a living will to address life-support issues. Creating a letter of instruction regarding burial or memorial preferences should also be considered. If such documents do not exist, an unmarried individual may find that his or her partner's blood relatives will be allowed to make these key decisions if the need arises.

Unmarried couples with children face another concern: legal guardianship. Nearly 40 percent of unmarried couples have children under the age of 18.(1) Yet legal guardianship of these children might not be as sound as it is for married couples. Because of this, unmarried couples should consider signing a written agreement acknowledging parental rights and responsibilities and having each partner name the other as primary guardian in wills.

Achieving a Comfortable Retirement

Although both married and unmarried couples need to save for retirement, unmarried couples may need to save more. Why? Because they will not be eligible for each other's Social Security benefits and, in some cases, employer-sponsored retirement plan distributions. Unmarried partners should check their plan rules and specify plan beneficiaries. The IRS now allows a nonspousal beneficiary of an IRA to take required distributions over his or her lifetime rather than in a lump sum, allowing for potential tax-deferred growth over a longer period of time. Therefore, you may wish to contribute the annual maximum to an IRA ($5,000 in 2011; $6,000 age 50 and over) before maximizing contributions to an employer-sponsored retirement account.

Annuities may also be an attractive investment vehicle since they allow for unlimited after-tax contributions, regardless of income or sources of income. Additionally, the payout methods of annuities usually include insurance features, enabling a named beneficiary or beneficiaries to receive payments if the owner dies before withdrawals begin.

When discussing retirement issues with your trusted advisors, remember to review all financial documents, including employer-sponsored retirement accounts, IRAs, annuities, and life insurance policies to ensure named beneficiaries are consistent with those mentioned in wills.

Estate Planning Issues

For a spouse, a marriage certificate is the gateway to a number of financial benefits that unmarried partners do not necessarily possess. This disadvantage is especially apparent in regard to estate planning.

It's essential for domestic partners to create wills. If you die without a will, the state may distribute your partner's assets to his or her closest blood relatives. To help rebut a challenge to a will, domestic partners may want to videotape their wishes in the presence of an attorney. Additionally, a living trust may be desired because it remains confidential and is not subject to probate.

Transferring assets upon death requires careful planning for unmarried partners. For example, federal tax law allows all assets to pass to a spouse tax free and no applicable estate taxes are due until the second spouse dies. Unmarried couples do not enjoy this tax advantage.

If you have significant taxable assets, it will be necessary to pursue other avenues to potentially reduce estate tax. Currently, the federal estate tax is 35 percent on estates over $5 million, but the rate is scheduled to increase to 55 percent and apply to estates in excess of $1 million in 2013 unless Congress enacts new legislation. To help reduce tax liabilities for the surviving partner, you can purchase life insurance to pay any potential federal and state estate taxes. A surviving partner must own the insurance to avoid it becoming part of the estate of the deceased. Therefore, each partner must own enough insurance to pay any anticipated taxes on the assets of his or her partner.

Estate Planning for Domestic Partners

An unmarried partner may wish to bequest a portion of his or her estate to children from a previous relationship or to charity. Here are two legal mechanisms to help achieve these goals while still providing for a significant other's financial security. Note: Because trusts are complex instruments, consult a competent estate planning attorney.

Total Return Trust

Similar to a charitable unitrust, this mechanism may potentially provide both income (for the remaining partner, who is the income beneficiary) and long-term capital appreciation (for grandchildren or other principal heirs). Defining income as a percentage of the principal of the trust's assets should appease both parties.

Life Estate

If a home is only in one person's name, the homeowner can include a "life estate" stake in the home to the partner in his or her will. This gives possession of the home to the remaining partner ­- to live in the home or rent it and retain the rental income – for the remainder of his or her life. Upon the death of the second partner, the title of the property transfers to the heir(s) in the will.

Points to Remember

1. Unmarried couples may wish to create a domestic-partnership agreement, which should detail the sharing of expenses as well as the ownership and distribution of assets should the relationship end.

2. Legal protections, such as durable power of attorney and health care proxy documents, and in some cases, a living will, can help safeguard decision making control, if one partner is unable to make financial or health care decisions.

3. Domestic partners may need to save more for retirement than married couples. Annuities and IRAs may be attractive retirement savings vehicles for such couples.

4. Careful estate planning, including the use of trusts, may be appropriate for effective wealth transfer as unmarried partners will not enjoy tax advantages that federal law bestows upon spouses.

Source: U.S. Census Bureau, based on 2009 census estimates (latest available).

Courtesy of Craig Rosenberg, Portfolio Manager, First Vice President, Financial Advisor at Morgan Stanley Smith Barney in Traverse City. If you'd like to learn more, contact Rosenberg at 932-7212.