Financial Planning for Unmarried Domestic Partners

How times have changed. Only 26% 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% of households fit in that category.1 Meanwhile, over the past 40 years, the number of unmarried couple households has increased by a factor of four, to over 6% of the population; there are currently about 7.5 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% of unmarried couples have children under the age of 18.1 Yet legal guardianship of these children may not be as sound as 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 2012; $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% on estates over $5.12 million, but the rate is scheduled to increase to 55% 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.

¹Source: U.S. Census Bureau, based on 2011 census estimates.

Potential purchasers seeking to use an annuity to fund a qualified or other tax-advantaged retirement plan should understand that the use of an annuity for such purpose is not necessary to defer taxation of investment earnings.

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Morgan Stanley and its Financial Advisors do not provide tax or legal advice, are not “fiduciaries”( under ERISA, the Internal Revenue Code or otherwise) with respect to the services or activities described herein, and this material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals should consult their personal tax and legal advisors before making any tax or legal related decisions. Article by McGraw Hill and provided courtesy of Morgan Stanley Financial Advisor. The author(s) are not employees of Morgan Stanley Smith Barney LLC ("Morgan Stanley"). The opinions expressed by the authors are solely their own and do not necessarily reflect those of Morgan Stanley. The information and data in the article or publication has been obtained from sources outside of Morgan Stanley and Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of Morgan Stanley. Neither the information provided nor any opinion expressed constitutes a solicitation by Morgan Stanley with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned.

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CRC 557552 (09/12)

Tying the Knot: Financial Considerations for Same-Sex Spouses

 

Since 2004, six states and the District of Columbia have opted to permit same-sex marriage. And others could soon follow suit, depending upon the outcome of an approaching Supreme Court decision on the constitutionality of same-sex marriage bans in several states and pending challenges to the Defense of Marriage Act (DOMA).

For same-sex couples contemplating marriage, tying the knot confers many legal rights and benefits. But from a financial perspective, the benefits are limited since gay marriages are currently not recognized under federal law. This fact alone effectively negates many of the financial benefits enjoyed by traditional married couples.

Below is a summary of the major financial benefits that married same-sex couples are likely to encounter. Keep in mind that these represent only a few key financial areas affected by same-sex marriage. Many other laws, including child custody rights, are also affected but not dealt with here. Also note that tax rules vary from state to state, even among those states that do recognize same-sex marriages.

 

States With Same-Sex Marriage and Civil Unions

 

Source: Boston.com, June 10, 2012.

 

Income Tax

On the state level, same-sex couples can file joint returns in states that permit same-sex marriage. That means they can share deductions for children, mortgage payments and other items that can generate significant state tax savings, especially for couples with lower incomes. However, since same-sex marriage is not recognized at the federal level, they still need to file separate forms and cannot share any spousal exemption or federal deductions. That said, joint filers with higher combined incomes may pay more taxes on the federal level anyway—the so-called marriage penalty—but this does not kick in until both earn a combined taxable income of over $142,700 in 2012.

Whether you pay more or less state tax when filing jointly, one thing is certain: Filing income taxes is likely to be more complex for same-sex couples who file a joint state return. Because you cannot piggyback your state tax filing off your federal return, tax preparation is likely to take more time.

Estate Tax

For same-sex spouses in states that recognize gay marriage, no state “death tax” applies. Such taxes, in a handful of states, typically piggyback off the federal estate tax. In these states, same-sex spouses can claim a spousal exemption. However, on the federal level, estate taxes may still apply since the I.R.S. does not recognize same-sex spouses. Thus, a same-sex widow must currently pay federal estate tax on a spousal inheritance above $5 million, and unless Congress acts, that threshold is scheduled to drop to $1 million on Jan. 1, 2013. Note that federal estate tax rates run high—currently at 35%, these taxes will increase to 55% in 2013.

The good news for same-sex spouses is that under most states’ laws, a spouse is the first in line of inheritance, even in the absence of a will. Surviving spouses can also make certain critical decisions following the incapacitation or death of a spouse. But keep in mind that this holds true only in states that recognize same-sex marriage.

Medical Proxy

In states that recognize same-sex marriage, same-sex spouses areable to make medical and financial decisions if their spouse is incapacitated. But this applies only in states that recognize same-sex marriage. So if you end up incapacitated in a state that does not recognize same-sex marriage, your partner could be powerless.

Health Insurance

Arguably the biggest financial benefit available to same-sex spouses is joint coverage under their health care plan. Shared coverage can save thousands of dollars a year in premiums. Some insurance companies require marriage for shared coverage. Others may offer coverage to domestic partners and same-sex unions, but the value of a partner’s benefits may have to be reported as taxable income. Although rules vary by state, same-sex couples generally qualify for shared coverage in states that recognize gay marriage, and need not report benefits as taxable income on the state level.

Retirement

In the retirement arena, there are few benefits currently afforded to same-sex spouses, since Social Security and qualified retirement savings vehicles such as IRAs, 401(k) and 403(b) plans, fall under federal jurisdiction. Accordingly, same-sex spouses cannot set up joint qualified retirement savings accounts and are not entitled to spousal death benefits under Social Security rules; Social Security benefits will cease upon your death. Likewise, should your partner die first, you will no longer receive benefits.

Divorce

Like traditional married couples, same-sex married couples are subject to a state’s divorce laws. Typically, everything you and your spouse acquired from the day you were married is subject to division. The exceptions are individual inheritances, gifts to an individual spouse and assets acquired before marriage. When assets are divided, the court considers each spouse’s earning ability, the length of the marriage and how much each spouse contributed to building household assets.

The exception to this are the nine “community property” states—Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Under the laws of these states, almost all assets will automatically be divided equally.

Such protections can be viewed as a positive or a negative, depending on whether you’d be the receiver or payer. And if one partner ends up paying spousal support, those payments cannot be deducted on their federal taxes, as is the case for traditional married couples.

 

Planning Tips

With these points in mind, married same-sex couples might want to consider a few planning tips:

Make a detailed estate plan, including health care proxy and power of attorney. You should also consider setting up a living trust to avoid probate. An estate plan is a good idea for any married couple, but it is especially important for same-sex couples since their spousal legitimacy is not recognized in many states. This could potentially mean that all assets of a deceased same-sex spouse who died without a will would automatically pass on to his or her next of kin rather than his or her spouse.

Designate beneficiaries on all retirement accounts. This will help in settling yours or your partner’s estate, since assets in these accounts will pass to the beneficiary you designate. If you do not designate a beneficiary, the assets will be distributed according to the terms of your will. But if you have no will, the state will determine who receives the assets, which may well not be your partner.

Consider having your taxes prepared by a professional. If you prepare your own tax returns—even if you use TurboTax or another tax-preparation package—it can get very complex filing joint state returns and separate federal returns. Most states piggyback off federal forms, so you may find yourself having to fill out a joint federal form just to arrive at a joint calculation only used in your state filing—in addition to filling out and filing separate federal returns.

Keep track of what states recognize (but not necessarily issue licenses for) same-sex marriage. This is especially important if you have multiple residences in different states or if you or your spouse are incapacitated in a state that does not recognize other states’ same-sex marriage laws. Your rights and benefits could vary significantly as soon as you cross the state line.

Keep good records. The laws are changing in many states, and Supreme Court decisions and challenges to DOMA could impact gay marriage on the national level. So make sure to keep records of all financial transactions that could be impacted by future changes to state or federal laws governing same-sex marriage.

Work with a professional. Whether it’s investing, saving for retirement or putting together an estate plan, let Morgan Stanley help you meet the unique challenges same-sex couples face today when planning their finances.

 

 

Tax laws are complex and subject to change. This information is based upon current federal tax rules in effect at the time this was written. Morgan Stanley and its Financial Advisors do not provide tax or legal advice. This material was not intended nor written to be used for the purpose of avoiding tax penalties that may be imposed on the taxpayer. Individuals are urged to consult their personal tax or legal advisors to understand the tax and related consequences of any actions or investments described herein.

Article by McGraw Hill and provided courtesy of Morgan Stanley Financial Advisor.

The author(s) are not employees of Morgan Stanley Smith Barney LLC ("Morgan Stanley"). The opinions expressed by the authors are solely their own and do not necessarily reflect those of Morgan Stanley. The information and data in the article or publication has been obtained from sources outside of Morgan Stanley and Morgan Stanley makes no representations or guarantees as to the accuracy or completeness of information or data from sources outside of Morgan Stanley. Neither the information provided nor any opinion expressed constitutes a solicitation by Morgan Stanley with respect to the purchase or sale of any security, investment, strategy or product that may be mentioned.

The FA may only transact business in states where he/she is registered or excluded or exempted from registration, FINRA Broker Check http://brokercheck.finra.org/Search/Search.asp. Transacting business, follow-up and individualized responses involving either effecting or attempting to effect transactions in securities, or the rendering of personalized investment advice for compensation, will not be made to persons in states where the FA is not registered or excluded or exempt from registration.

Investments and services offered through Morgan Stanley Smith Barney LLC, member SIPC.

CRC530583[08/12]