by JT Hatfield Smith, CFP®, ChFC®, CLU®, ADPASM, CEP®, CLTC, and Helen M. Whelan, J.D., LL.M.
JT Hatfield Smith focuses on creating customized financial plans designed to help members of a committed life partnership from unexpected financial surprises and irrevocable outcomes due to lack of appropriate planning. For many domestic partners, this anti-crisis financial planning process is often complicated because their relationship is not recognized or protected in their state or at the federal level.
Helen M. Whelan, J.D., LLM, is a partner with Elville & Associates, P.C., with offices located in Columbia and Rockville Maryland. Ms. Whelan counsels clients with issues regarding their estate and tax planning. Her goal is to educate her clients so that they understand their estate plan and how it will be implemented, both during their lifetime and after their death. Her practice also includes elder law, and her clients include families, individuals and same sex couples.
In its 2009 American Community Survey, the U.S. Census Bureau estimated that of the 113.6 million United States households, 6.5 million were comprised of unmarried partners1, defined by the Census Bureau as adults having a close relationship while maintaining a shared household. Although unmarried partners represent only a small percentage of all households, they do represent a growing trend in the United States, as the number of unmarried households has increased by over one-half million since 2004.2 Many readers may associate unmarried couples as members of either the gay, lesbian, bisexual, and transgendered (GLBT) community, or a younger generation cohabitating as a "test-drive" before marriage. However, with nearly 80 million baby boomers retiring within the next several years,3 there will be millions of widows and widowers who may, for financial and emotional reasons, cohabitate for companionship without the desire to commingle assets. It is important that advisers recognize the different challenges in planning for this growing population of unmarried couples.
When planning for unmarried couples, who do not have the same legal protections as married couples, financial service professionals help inform these couples of the extra steps needed to help ensure that this group of clients is properly prepared in the event of a life-changing event, such as dissolution of a relationship, disability (incapacity), or death. It is essential that a client is informed of how to plan for the disposition of his or her assets. As planners in this market, it is important for us to help ensure that the client's wishes are followed at the time of his or her incapacity and death.
Get to Know Your Client
It is important for a financial planner to get to know the client, both personally and financially. In order to properly plan for an unmarried couple, an adviser should understand the client's family dynamics, the client's wealth, and the client's expectations. After the planner has a handle on these important areas of the client's life, an estate plan can be developed.
The planner should know if the client has any children and other living relatives and know which family members (e.g., children, a partner, nieces or nephews, or parents) the client wishes to care for or to exclude from his or her estate plan. If dealing with a member of the GLBT community, it is important to ascertain if the biological family is aware of the relationship and which members of it are supportive of the relationship. It is important to note that when dealing within the GLBT communities, families are not always abreast of a gay relationship or the personal commitments of a gay client. In this case, the more done to keep the estate transfer private, the better the chance of fulfilling the client's goals and providing for a smooth transition.
The planner should ascertain the client's wealth, including the earnings potential of the client's assets. The planner should know the liquid assets; the amount and types of insurance; the business interests; and the amount, location, type, and title of real estate. The client's assets play an important role in estate and tax planning.
Finally, the planner should ask about the client's expectations for the future. What is the standard of living to which the client is accustomed? Does the client want to maintain that standard of living for his or her partner or for himself or herself? Has the client ensured that his or her estate plan disposes of the client's assets in accordance with his or her wishes? The tax adviser must understand and inform the client of the tax consequences or concerns that could occur because of the client's desired course of action.
Documents Can Provide Protection for Your Client
Financial Power of Attorney
An important part of lifetime planning is the power of attorney (POA) for financial matters. Valid in all states, these documents give one or more persons the power to act on another's behalf. The power may be limited to a particular activity or general in its application. The POA may take effect immediately or upon the occurrence of a future event, which most commonly is disability.
Choosing the appropriate person to act, determining when the POA becomes effective, and documenting the limits and scope of the powers are major decisions for the client. The individual or individuals named to act on a principal's behalf are typically known as the "agent" or "attorney-in-fact." The agent has the power to make legal and binding decisions on the principal's behalf.
Special Vs. General
POAs can be either special or general. Special POAs impose limits on the scope of the agent's authority. The scope may vary, as it can enable the agent to act on a particular transaction or an entire account. General POAs are unlimited in duration and scope and permit the agent to act on behalf of a principal in connection with all matters identified in the POA until the POA is revoked.
Durable Vs. Springing
A durable POA allows the agent to act on behalf of the principal until the POA is revoked by the principal or upon the principal's death. The durable POA is effective upon signing and remains effective even during the principal's incapacity. A springing POA becomes effective upon a certain event, such as the disability or incapacity of the principal. A springing POA can pose a problem if it requires that two doctors attest to the principal's incapacity before the POA is effective. There is the potential for disagreement among doctors as to the degree of incapacitation, which could result in banks and other financial institutions rejecting an agent's authority. If this scenario arises, the matter could wind up in court, which is the very thing advisers should be trying to avoid. Springing POAs are the best alternative when the principal does not feel comfortable delegating a higher level of authority immediately. Although the springing POA offers better protection of the principal's assets, it may substantially delay or frustrate the purpose of the POA.
If a client does not have a POA and becomes unable to manage his or her business or personal affairs, the courts may appoint one or more persons to act on the client's behalf. People appointed in this manner are known as guardians, conservators, or committees, depending on state and local law. A court proceeding or intervention is expensive and time consuming, and the client may not have the ability to choose the agent who will act on his or her behalf.
Facts:
- Pat and Chris have been together for a short time but are committed to the relationship.
- Pat owns a vacation property that he purchased prior to meeting Chris.
- Pat does not want to retitle the property because of potential gift taxes and control issues.
- Pat wants to ensure Chris can continue to maintain the house with Pat's funds should Pat become incapacitated during his lifetime.
Challenge:
- If Pat becomes incapacitated, how could Chris make payments on Pat's property from Pat's funds?
Possible Solution:
- A special, springing power of attorney empowering Chris to write checks from Pat's bank account to pay the mortgage and expenses for this vacation property.
-
With this strategy, Pat does not relinquish control of any assets while he has capacity and has limited the control delegated to Chris only if Pat becomes incapacitated.
Health Care Documents
Durable Power of Attorney for Health Care
In the event of a medical emergency, a durable power of attorney for health care provides hospital access and visitation rights and enables the principal to designate an agent to make medical decisions on the principal's behalf. The law in many jurisdictions does not recognize unmarried couples as family; accordingly, a durable power of attorney for health care is vital.
Example: Pat and Chris are in a car accident. Pat is seriously injured, but Chris has only minor cuts. Chris joins Pat in the ambulance to the hospital, but upon arriving at the hospital, Chris is required to remain in the waiting room. With the implementation of HIPAA, Chris will be denied access to Pat's medical information without the proper durable power of attorney for health care. In the event a medical decision becomes necessary, only family members will be consulted. Chris has no authority to make decisions and is not entitled to receive any information on the status of his partner.
Advance Medical Directive
An advance medical directive is a document written in advance of a serious illness and identifies an individual's wishes in the event of severe medical conditions, which may include a coma, a vegetative state, or terminal illness. The advance medical directive will enable the agent designated in the durable power of attorney for health care to step in and ensure the client's wishes are carried out. The advance medical directive can ease some of the pain loved ones have if required to make life-determining decisions when they are already in an emotionally difficult situation. Without the advance medical directive, the family is consulted on all issues dealing with the client's level of care, and the unmarried partner is not included in making medical decisions.
Domestic Partnership Agreement
A domestic partnership agreement (DP agreement) is a legally enforceable contract between two unmarried people. The DP agreement sets forth the rights and obligations of each partner with regard to the property each partner brings into the relationship and acquires throughout the relationship. The DP agreement is similar to a prenuptial agreement for married couples.
The DP agreement is designed to protect both partners in the unmarried relationship. The DP agreement lays out each partner's rights and the parameters for how property is divided between the partners in the event the relationship is terminated. The largest commonly shared asset is typically the partners' residence. Determining each partner's proportionate share of the residence and the method of valuation is much easier when the relationship is going well.
The DP agreement identifies what each partner brought to the relationship and each partner's respective ownership share of particular assets.
Last Will and Testament
The last will and testament (will) provides a mechanism for disposition of the client's individually owned assets through the probate process. Although a client may have a revocable trust, he or she should still have a "pour over" will, which serves to instruct the personal representative to transfer individually owned assets to the trust.
The disadvantage of the will is that it must be probated in the state of the testator's primary residence or domicile, and ancillary probate must occur in any other state where real property is owned individually. The will becomes a public document during this process. Probate is the process by which all assets individually held that do not have a beneficiary designation or other survivorship provision are distributed to each individual's legatees. The will allows each individual to set forth how his or her assets should be distributed.
Revocable Trust
A revocable trust, also called a "living trust," can be another useful tool for unmarried couples' estate planning. Revocable trust assets are included in the taxable estate of the trust's creator (e.g., "grantor" or "settlor"). However, a significant benefit of the revocable trust is that assets held in trust are not part of the deceased grantor's probate estate, and therefore will avoid the process of probate. Unlike a will, a revocable trust is not a public document. In order for the trust to be truly effective and avoid probate, the grantor must retitle the assets to the revocable trust, the trustee of which is typically the grantor during the grantor's lifetime. Therefore, the grantor enjoys total control and use of the assets during his or her lifetime.
Example: Pat inherited a vacation property prior to meeting Chris. If Pat predeceases Chris, he wants Chris to be able to enjoy the property for the remainder of Chris's life without a concern about the expenses associated with maintaining the property. Pat wants to keep the property in the family after Chris's death. Pat could retitle the property in his capacity as trustee of his revocable trust to enable Chris to use the property for the remainder of Chris's life and have all expenses that relate to the property paid from the trust assets. After Chris's death, the property could then be distributed to Pat's family.
Titling Assets
For unmarried couples the adviser must identify the client's assets and understand each client's concerns and eventual goals. Unmarried couples, like married couples, typically have three categories of assets: "mine," "yours," and "ours." When sorting through client statements and accounts, the adviser should not make any assumptions about why accounts are set up in a specific manner. Educating a client is the key to ensuring that the client is not surprised by the unexpected ramifications of his or her decisions.
Example: Pat and Chris are an unmarried couple. They each have their own separate checking and savings accounts. In addition, they have a joint "household" account, to which they each contribute for their joint monthly expenses.
Individual Title
Assets may be titled in an individual's name. The individual is the sole owner of the asset and has complete control of the asset during his or her lifetime.
Transfer on Death
Assets titled individually may also have a beneficiary designation. Assets titled "transfer on death" or "payable on death" will pass to the beneficiaries named on the account or asset at the time of the account holder's death.
For nonretirement accounts, consider a transfer on death (TOD), or "payable on death," agreement. Some financial institutions do not offer TOD agreements. Beneficiaries and contingent beneficiaries should be designated for retirement accounts and insurance policies in order to provide for a more efficient transfer at the time of the account holder's death and for avoiding probate. It is important to note that these designations can only be created with certain types of depository accounts or securities and cannot be used to convey real property.
If the client wishes to keep his or her assets titled separately, the combination of a POA (which, depending on state law, may need to be specific for the institution) for access during incapacity and a TOD for efficient transfer at death might meet his or her needs. An added benefit is the client can make changes to the TOD beneficiary designations at any time by informing the institution of the change.
Joint Tenants with Rights of Survivorship
Titling assets as joint tenants with rights of survivorship (JTWROS) permits two or more individuals to hold title, with each individual owning an undivided equal interest in the whole of the property. At the time of the first joint tenant's death, the property will pass to the surviving joint tenant(s) by operation of law. All ownership interests are equal. Any joint tenant may transfer or use the property as collateral without the consent of the other joint tenants. However, this may sever joint tenancy in some jurisdictions.
A problem can arise with JTWROS when one owner withdraws funds from an account without the knowledge and consent of the other owners. Additionally, adding an individual's name to an account for easy access or direct transfer at death can lead to potential liability issues, as creditors of the added individual could attach the assets. Unintended gift taxes may arise if amounts are withdrawn in unequal proportions and exceed the excludable amount set by annual gifting limits.
An additional problem can occur at the time of death of the first joint tenant. Even though an asset is not part of the decedent's probate estate, the asset's entire value may be treated as part of the decedent's taxable estate. However, if the surviving joint tenants are able to document their monetary contribution to the joint asset, then only the value of the decedent's contribution will be included in his or her federal taxable estate. It is worth noting that individual states may have different rules in connection with taxation at the time of the death of the first joint tenant.
Tenants In Common
In titling assets as tenants in common, two or more individuals own undivided shares of the property. Ownership shares may be equal or unequal.
At the time the first owner dies, the surviving owners do not receive the decedent's interest by operation of law. The deceased owner's interest will pass according to the decedent's will (or trust, if the property was appropriately titled) or otherwise according to local intestacy laws. This could be a problem, especially in real estate, if the surviving owner is forced to share ownership with a beneficiary who is unfriendly or adversarial.
Real Estate
Currently, unmarried couples cannot file a joint federal income tax return (certain states may permit a joint return), and therefore income tax issues are of particular importance to unmarried couples when determining how to title real property.
It is important to ascertain who is on the title as well as who is responsible for the mortgage. If the mortgage is held in one partner's name, and each partner pays half of the monthly mortgage payment, only the partner on the mortgage may deduct the mortgage interest and his or her deduction may be limited to half of the mortgage interest paid. If the mortgage and the title to the property are in both partners' names, the mortgage interest deduction may be allocated to each partner depending on who made the payments.
Example: Pat is in a high tax bracket. Chris has minimal itemized deductions aside from his portion of the mortgage interest (assuming he is liable on the mortgage). It would be advantageous to have Pat pay the entire mortgage and deduct all of the mortgage interest if it will maximize his deductions and reduce his tax liability. If Chris's contribution to the mortgage would have been minimal, it might be beneficial for Chris to forego the itemized deduction for mortgage interest, as his standard deduction would provide a better tax result.
Without the marital deduction, unmarried couples must find creative ways to minimize their estate taxes with regard to this large asset.
Real estate owned by unmarried couples can be titled as tenants-in-common or joint tenants with rights of survivorship, or held in a revocable trust. Tenants-by-the-entirety is usually reserved exclusively for married couples (some states now recognize tenants-by-the-entirety for unmarried couples). How the client titles property will depend on the goals the adviser and client are trying to achieve.
Tax Planning Devices
Qualified Personal Residence Trust
A qualified personal residence trust (QPRT) may remove the value of the client's home from his or her gross taxable estate. One form of a QPRT involves creating an irrevocable trust to which the current owner (or "grantor") conveys title of his or her residence. The grantor retains the right to use the property for a term of years, and after that term of years expires, title to the property passes to the named beneficiaries of the trust, or remains in trust for the benefit of the named beneficiaries.
The transfer of the property to the QPRT will be treated as a gift of the remainder interest to the beneficiary(s), such as the grantor's partner. The grantor must file a gift tax return for the remainder interest in an amount equal to the fair market value of the property less the value of the retained interest. Therefore, the longer the term of the QPRT, the smaller the gift tax liability. The goal is to offset this tax by using the gift tax credit to cover the gift tax liability. There is a risk in making the term of the QPRT too long. If the grantor dies before the end of the term of the QPRT, the residence will be included in the grantor's taxable estate. If the grantor lives beyond the term of the QPRT, the grantor has the option to continue residing in the property but will be required to pay fair market value rent.
Intentionally Defective Grantor Trust
An intentionally defective grantor trust (IDGT) is a sophisticated estate planning device. The IDGT is an irrevocable trust designed with enough powers reserved to the grantor to identify the grantor as the owner of the IDGT assets for income tax purposes. However, assets transferred to the trust will be treated as a completed gift for federal estate tax purposes.
If the unmarried partner is the beneficiary of the IDGT, the IDGT can increase cash flow to that partner. The IDGT does not pay taxes because the IDGT is a grantor trust.
The IDGT can be used to avoid recognition of gain at the time of transfer to the trust. The grantor's sale of property to an IDGT is a nontaxable event. That no gain is recognized results in the transfer to the trust of assets that retain their cost basis, but keeps appreciation after the date of the transfer out of the grantor's estate.
The IDGT can retain certain tax attributes. The grantor's tax attributes are retained and applicable to the trust income. Thus, the grantor's carryover of passive losses, investment interest, and capital losses can be applied to trust income and deductions.
A deduction for home mortgage interest is available if the trust holds a mortgage. In addition, the exclusion on the sale of principal residence would be available if all of the Sec. 121 requirements are met.4
Risk Management With Proper Insurance
Long-Term Care Insurance
Many people have unrealistic expectations when it comes to at-home care of an incapacitated or handicapped partner. Although the healthy partner may have the genuine intention of caring for the incapacitated partner, it may not be feasible financially or otherwise to assume the healthy partner can give the incapacitated partner the care he or she requires. With long-term care costing an average of $83,585 per year in 2010,5 the cost of care can significantly erode the principal of a portfolio. Long-term care insurance should be viewed not merely for the benefit it provides to an individual requiring medical care but also for the freedom it provides to the care-giving partner, who may need to work.
It may be advantageous to have the long-term care insurance policy owned by the partner or in trust for the benefit of the partner with the least amount of assets. If the partner with the least amount of assets is incapacitated, then the benefits would be used to provide for his or her long-term care. If the partner with more assets is incapacitated, then that partner's assets would be used to pay for his or her expenses, and the policy benefits would continue to be in place for the benefit of the partner with the least assets outside of gift- and estate-tax limits.
Although long-term care is getting more expensive, more companies are coming out with discounts for unmarried couples that cohabitate, in an effort to be more competitive in the market. There is typically some type of cohabitation clause that requires the insured to have lived with his or her partner for a minimum of one year. Satisfying this one-year requirement can benefit the couple with a substantial savings in premium payments.
Life Insurance
Special care should be taken when obtaining or reviewing life insurance policies for unmarried couples. The planner should recognize that there are special considerations when determining life insurance needs and that there may exist insurable interest challenges when attempting to obtain coverage.
Term insurance simply provides insurance for a specified period.
Permanent insurance combines a death benefit similar to term insurance with a potentially tax-sheltered savings arrangement. Permanent life insurance policies are meant to be held until death, with premium payments typically made to the insurance company for the duration of the insured's life. These policies usually have higher premiums than term insurance. If the client's goals are consistent with the benefits of permanent insurance, the tax advantages can make permanent life insurance a valuable investment within the client's overall financial portfolio. At the assumed mortality age, most permanent policies will provide an income-tax-free return of 5 percent to 7 percent per year. If the insured dies before his or her anticipated mortality age, the return will be higher; if the insured lives past his or her anticipated mortality age, the return will be lower.
Employer-sponsored life insurance is insurance provided by an employer as part of a benefits package, or it may be available for purchase through payroll deductions. The client's goals for insurance and employment longevity should be discussed. Clients should be advised that group policies are rarely portable.
Younger, healthier individuals can typically find less expensive insurance with a private policy outside of their employer because their rate will not be averaged in with older and less healthy employees. A client would be well advised to compare the cost of the employer sponsored policy with the private policy.
The face amount death benefit of the policy for employer-sponsored, or group term, insurance will be added to a deceased's gross estate.
Owner/Insured/Beneficiary
Advisers should determine the owner, the insured, and the beneficiary of the client's life insurance policies in order to determine their effect on the estate. The owner is the person who has the rights stipulated in the contract. Among other rights, the owner may name a beneficiary, participate in dividends from the policy, surrender the policy for its cash value, or transfer ownership. The insured is the person by whose life the policy is measured and upon whose death the benefits are paid. The beneficiary is the person designated to receive the proceeds of the life insurance policy at the time of the insured's death.
Life insurance proceeds pass to the beneficiary income tax free. Unfortunately, if the proper steps are not taken to secure appropriate ownership, the entire amount of the life insurance proceeds could be added to the decedent's taxable estate for federal and state estate-tax purposes. Identifying the client's goals and properly structuring the policy is important in determining how the policy will pass at the insured's death. It is important to check beneficiary designations and keep them up to date.
Cross Ownership
Usually the same individual is both the owner and the insured. However, for unmarried couples it may be beneficial for each partner to purchase a life insurance policy on the life of the other partner. Accordingly, if the insured and the owner are not the same person, the proceeds of the life insurance policy will not be includible in the insured's taxable estate, provided the insured did not have any incidents of ownership within three years of his or her death.
Irrevocable Life Insurance Trust (ILIT)
An irrevocable life insurance trust (ILIT) is an irrevocable trust that owns a life insurance policy. As with any other trust, an ILIT is a contract created between a grantor and a trustee, and it is used to administer the insurance contract in accordance with the terms of the trust for the benefit of designated beneficiaries. The ILIT cannot be amended or modified after it is created. The ILIT is the beneficiary of the life insurance policy, and the terms of the ILIT govern distribution of the proceeds from the life insurance policy.
Review of Life Insurance
An adviser must review the client's life insurance policies; for example:
|
Pat and Chris have the following life insurance: |
||||||
|
Owner |
Insured |
Beneficiary |
Insurance Company |
Plan Type |
Face Amount |
Cash Value |
|
N/A |
Pat |
Chris |
Employer Group Term |
Term Life |
$75,000 |
N/A |
|
N/A |
Chris |
Pat |
Employer Group Term |
Term Life |
$390,000 |
N/A |
|
Pat |
Pat |
Pat’s Estate |
Rainbow Mutual |
Variable Univ Life |
$1,500,000 |
$100,000 |
|
Pat |
Pat |
Shannon, Pat’s Ex |
Rainbow Mutual |
Term Life |
$100,000 |
N/A |
Assuming these policies are sufficient amounts of life insurance for the couple, an adviser may consider some additional planning. The adviser should discuss performing an efficiency study to determine if Pat's and Chris' employer-sponsored term life insurance should be converted to private insurance policies. In the event it is not practical or possible to purchase private policies, irrevocable designations should be considered. If moving the group term policies to private policies would be more efficient, cross ownership should be considered.
The estate should never be listed as a beneficiary. Accordingly, the adviser should determine Pat's goal for listing his estate as the beneficiary on the VUL policy with Rainbow Mutual. The beneficiary should be updated to remove the estate. The adviser may consider having Pat transfer ownership of Pat's policy to an ILIT; however, Pat should be advised that the policy would still be included in his estate if he passes away within three years of the transfer. Alternatively, Pat may wish to have Chris purchase the policy from Pat so that Chris is the owner. Please note that if Chris buys the policy from Pat, then the life insurance proceeds may be subject to income tax at Pat's death.
The adviser should review the beneficiary designation of Pat's ex, which may be an oversight. In addition, the planner should inform the clients of consequences resulting from the dissolution of their relationship. The adviser may wish to suggest alternative ways in which to deal with a dissolution, such as the creation of a DP agreement.
Homeowners, Auto, and Liability Insurance
It is common for clients to maintain insurance coverage at the mandated required limits and to shop around for the lowest insurance rates. This may result in different insurance companies for multiple purposes. The planner should review the insurance policies to help determine if that insurance coverage is sufficient.
Homeowners Insurance
For most clients, their home is their most valuable asset. Homeowners insurance ensures the clients will have sufficient funds to replace the contents of the home or rebuild the home in the event of a catastrophe. However, most homeowner's insurance policies do not cover earthquake or flood damage without a specific rider.
Auto Insurance
Auto insurance on each car must ensure that each partner is fully covered when he or she drives the other partner's car. In addition, auto insurance must protect each partner when he or she drives any car.
Umbrella Insurance
An umbrella policy is liability coverage that extends beyond the home and auto insurance policies. Unmarried couples are typically responsible for obtaining their own umbrella policies. Unfortunately, few companies offer coverage under one policy for unmarried couples, which results in a doubled expense. Another limitation may be that the insurance company will only offer an umbrella insurance policy if the insured has his or her auto and homeowners' policies with that company. Discounts may be available to clients who utilize multi-line policies with one company, making total coverage more affordable.
A planner should not assume that coverage is extended, or has been purchased, for unmarried couples simply because they are living together.
Liabilities
An adviser should review his or her client's liabilities as well as his or her assets. Unmarried clients may be individually liable or jointly and severally liable for credit card debt, auto loans, or home loans. When clients are jointly and severally liable, the client should understand that he or she is responsible for the entire amount of the debt in the event his or her partner walks away from the debt. A DP agreement may be an advantageous tool under certain circumstances in order to ensure that each partner is responsible for his or her fair share of the debt.
Retirement Assets
Beneficiary Designation
As discussed earlier, beneficiary designations for unmarried couples are a free pass for avoiding probate if set up correctly. It is imperative to ensure beneficiary information is both correct as well as up to date. A beneficiary designation can include virtually anyone or any organization.
A common pitfall in naming beneficiaries is the designation of "my estate" or "per my will" as the beneficiary. Such a designation will result in the retirement account being subject to probate and possibly to estate income tax. It will also preclude the beneficiary from taking advantage of the stretch provisions mention below. Other common pitfalls include not properly identifying beneficiaries or having incomplete information (full name, date of birth, and Social Security number), not designating contingent beneficiaries, and failing to plan for simultaneous death.
Stretch Provisions
A stretch IRA is an effective wealth transfer tool that enables an individual to pass IRA assets to a beneficiary who will use these assets over the beneficiary's lifetime, which could result in significant tax savings. In order to take advantage of stretch IRA provisions, the beneficiary listed must be a person or a qualifying trust.
If a trust is used as the beneficiary designation, the trust agreement must include four minimal requirements in order to be able to take advantage of the Stretch IRA provision:
- The trust must be irrevocable or become irrevocable at the owner's death.
- The trust must be valid under state law.
- The trust beneficiaries must be clearly identifiable as the designated beneficiaries as of September 30 of the year following the year of the owner's death.
The trust documents and any amendments and the list of trust beneficiaries must be provided to the IRA custodian and/or the plan administrator by October 31 of the year following the year of the owner's death.
Please note:
- An IRA account holder considering a stretch should have no need for money in the IRA before or after his or her required beginning date
- Stretching an IRA assumes the holder will take only required minimum distributions
- The beneficiary's tax liability is spread over a lifetime
- Tax laws and IRA rules can change over time, which may adversely impact the use of a stretch strategy
Pensions and Social Security
Most clients with pension plans (whether through the government, the military, or private industry) will not have an option to elect a joint and survivor payment if they are not married. This creates challenges for retirement planning if the individual with the pension predeceases his or her partner. Advisers should help determine if clients have the ability to receive their pension in a lump sum distribution at retirement instead of taking a lifetime annuity payment. If the client is able to take a lump sum, a decision can be made to set up a private single-premium immediate annuity with a joint and survivor benefit, or simply roll this amount into an IRA (satisfying requirements for the stretch provisions) and using the funds as needed.
IRA annuity products typically have restricted beneficiary designations. Although additional expenses are prevalent in these types of investment contracts, they can provide for income to a surviving partner during the remainder of his or her lifetime. Additionally, directions can be set up to distribute the remaining balances to a different beneficiary.
Social Security
Social Security has no provision for nonspousal benefits, so when planning for unmarried couples, advisers must find alternative means to replace this lost future income stream. It is common for couples to retire at different ages. Depending on sources of income and retirement goals, Social Security payments may be paid out at the earliest opportunity with a reduced-benefit payment.
When a client is approaching retirement, many assumptions have to be made about current income needs and future goals. A client might begin receiving Social Security payments with the expectation that the income is necessary but later find that he or she would receive a greater benefit by waiting to commence the benefits.
There is a rule that permits an individual who takes a reduced benefit, and subsequently discovers that it would have been more advantageous to wait and receive the full payment, to pay back the benefits received without interest, and then reapply for the higher benefit. Recent amendments to this rule, however, would limit the withdrawal of benefits to one per lifetime and would require the withdrawal to occur within 12 months of the first month of entitlement.6
Conclusion
Planning for unmarried couples presents unique challenges, whether it be the new couple testing out the relationship, the widow/widower that seeks companionship without commingling assets, or GLBT couples. All of these clients lack the same rights under the law married couples have.
An unexpected death is never easy; advising an unmarried client to have multiple layers of documentation will help ensure a smooth transfer of assets. The goal of layering is to document the client's intentions in multiple ways, that is, through multiple people, in multiple documents, and on multiple dates, which will help eliminate the client's assets being distributed to unintended beneficiaries.
There is no one-size-fits-all remedy for a client. Knowing your client and understanding his or her goal will help you to determine the best course of action for that client.
Endnotes
1 U.S. Census Bureau, 2009 American Community Survey.
2 U.S. Census Bureau, 2004 American Community Survey.
3 Betty W. Su, 2007, "The U.S. Economy to 2016: Slower Growth as Boomers Begin to Retire," Monthly Labor Review 130, 11 (November): 13, http://www.bls.gov/opub/mlr/2007/11/art2full.pdf.
4 See Laura Kauls and John Woodford, 2002, "Intentionally Defective? Estate Planning with Intentionally Defective Irrevocable Trusts-Brief Article" California CPA (September), http://findarticles.com/p/articles/mi_m0ICC/is_3_71/ai_91967453.
5 $229 average daily rate for a private room in a nursing home, up about 4.6 percent from 2009. MetLife Mature Market Institute, 2010, The 2010 MetLife Market Survey of Nursing Home, Assisted Living, Adult Day Services, and Home Care Costs, p. 4, http://www.metlife.com/assets/cao/mmi/publications/studies/2010/mmi-2010-market-survey-long-term-care-costs.pdf.
6 See "Amendments to Regulations Regarding Withdrawal of Applications and Voluntary Suspension of Benefits (Final Rule with Request for Comments)," 2010, Federal Register 75, 235 (December 8)): 76256.
This article is not a comprehensive guide for planning with unmarried couples, but rather an overview of issues and potential solutions for further research by the reader. JT Hatfield Smith is not an attorney or CPA, and any legal or tax concepts presented are for illustrational purposes only and not representative of any particular state or federal law. Helen Whelan is an attorney who practices in Maryland. Please note that the laws in this area are constantly changing. Please consult the appropriate professional before implementing any strategy or advice.
Helen Whelan is not affiliated with Raymond James Financial Services, Inc. or SPC Financial, Inc. JT Hatfield Smith is an Investment Representative with SPC Financial, Inc., an Independent Registered Investment Advisor, and offers securities through Raymond James Financial Services, Inc. member FINRA/SIPC, Rockville, MD 301-770-6800.
