Estate planning strategic for unmarried couples.
The Marital Deduction and the Unified Tax Credit
A planner considering the estates of married persons knows that estate tax law allows two basic, important tax breaks. The first tax break applies to property inherited by the surviving spouse of a marriage, and applies only when the surviving spouse is a United States citizen. This is called the "Unlimited Marital Deduction." (2) A surviving citizen-spouse is entitled to inherit an unlimited amount of property; the surviving spouse will have no federal estate tax liability owing to Uncle Sam. The second tax break available under the law is the use of the unified tax credit, which applies both to gifts made while alive and to property passed on by way of inheritance after death. The federal unified tax credit is a dollar amount (currently $345,800), which can be used to offset or pay the estate tax liability on a decedent's estate that is imposed by the federal estate tax law. Under current law, the equivalent amount of estate that is "sheltered" by this tax credit is $1,000,000 for the year 2002. (3)
The unified tax credit is not dependent on marital status. The first-to-die of an unmarried couple may transfer $1,000,000 tax-free to the surviving partner in the relationship. By contrast, the marital deduction allows the first-to-die-spouse to transfer any amount of wealth to the surviving spouse with no transfer taxes due. The unified tax credit is the centerpiece of estate plans for unmarried couples. However, estate planning is necessary if an unmarried person desires to transfer wealth in excess of $l,000,000 to a surviving partner in a tax-efficient manner. Table 2 summarizes the applicability of the marital deduction and unified credit to wealth transfers given marital status. The table also summarizes the consideration of marital status relative to the other wealth transfer strategies discussed in the subsequent sections of this article.
Unmarried couples may transfer wealth between each other or to other beneficiaries by annual gifting. (5) In 2002, the annual amount for excluded gifts rises from $10,000 to $11,000. If either or both partners recognize that their estates will exceed the amount of the lifetime exemption, he or she can establish a strategic program of annual gifting. Each year, $11,000 of wealth may be removed from the estate with no restriction on the beneficiary of the gift. However, the gift must be of a present interest--this means the donee must have an unrestricted right to the immediate use, possession, or enjoyment of the property or income. If the size of the estate is significant, it is best to initiate the gifting program as early as possible since only $11,000 may be transferred per year.
By designating gifts as "split gifts," (6) married couples can remove $22,000 annually from an estate even if one spouse owns all the couple's assets. The split-gift designation is not available to unmarried couples. Therefore, the annual gifting strategy by unmarried partners, while important and effective if used overtime, has only half the ability--in a given timeframe--granted married couples to remove wealth systematically from a sizeable estate.
Intestacy Laws/Community Property
Under the general laws of intestacy, if a married man or woman dies without a will, the surviving spouse automatically receives a portion of the estate according to state law. Under the Uniform Probate Code, the surviving spouse would receive $50,000 plus one-half of the residue of the deceased spouse's estate. In community property states, the surviving spouse would already own one-half of the community property, and would inherit the deceased spouse's entire share. (7) Additionally, the surviving spouse would receive a fraction of the decedent's separate property, usually one-half, or one-third, depending on the number of surviving children.
An unmarried partner does not have automatic rights to property owned by the other partner. This is why it is essential for unmarried couples to make arrangements prior to death for the transfer of property. Intentional transfers may be accomplished by will, trust, joint ownership or gift.
Techniques for Property Transfer/Wills, Titling, and Trusts
In order to assure that property is transferred according to the decedent's intentions, it is essential that both partners in an unmarried couple draft a will. A will may be revoked any time before death. Often, families of the deceased member of the couple may contest a will that leaves property to the surviving partner. Thus, relying exclusively on a will provision may not be the most effective way to arrange for property transfers.
Joint titling of assets can assure that property is transferred as intended. Effective joint titling for unmarried couples can be accomplished in several ways. The first is "joint tenants with right of survivorship", where the property will pass to the remaining partner by operation of law. Another option is titling as "tenants in common." With this option, the property goes to the person named in a will or trust, or goes to blood relatives if the deceased partner left no estate plan.
Since titling property as "joint tenants with right of survivorship" is a powerful tool to avoid probate, several additional considerations are noteworthy. If one unmarried partner has a $100,000 bank account in his own name and decides to re-title this bank account to "jointly owned with the right of survivorship" with his partner, a gift of $50,000 has not taken place. However, if the second partner then withdraws $50,000 for personal use, a gift would take place with that event. Joint titling can prove problematic if the unmarried partner relationship is not long-term. If the partnership dissolution is not amicable battles may ensue over property that has been jointly titled.
Unmarried couples may choose to use a living trust (8) to transfer assets. The trust can be structured so that the partner who is the beneficiary of the trust can receive current benefits as well as receive the property in trust upon the grantor partner's death. Assets transferred by will normally undergo probate and become a matter of public record. With a living trust, probate can be avoided. Although some costs are involved in establishing a living trust, the fees payable to a trustee and/or attorneys of a living trust tend to be lower than "statutory" probate fees, which are calculated based on the size of the estate. Further, it is important to note that qualified terminable interest property trusts (QTIP) (9) that allow married persons to delay the estate taxation on the assets of the first spouse to die until the death of the second spouse are not available to unmarried partners. To qualify as a QTIP, the property must pass between spouses.
Estate Charitable Deductions/CRAT
If one objective of unmarried persons with sizeable estates is to minimize estate taxes due, then charitable giving should be considered. As long as the bequest is made to a qualifying charity per IRS regulations, an unlimited estate tax deduction is allowed for charitable deductions. (10) The unlimited amount for charitable deductions is available to any estate and, therefore, does not depend on the marital status of the decedent.
An unmarried couple may wish to donate their assets to charity, but need to provide for the surviving partner upon the first-to-die's death. A charitable remainder annuity trust (CRAT) (11) allows a donor to transfer cash or appreciated property to a charity in return for an income stream that can result from the charity's reinvestment of the donated assets. The property donor to the CRAT is allowed an income tax charitable deduction for the actuarially determined value of the charity's remainder interest in the trust. Estate taxes can also be reduced because the value of the donated asset will be removed from the donor's estate. For unmarried couples the beneficiary of the income stream could be the donor; when the donor dies the beneficiary becomes the remaining partner until his death. Once all beneficiaries of the income stream are deceased, the CRAT's remaining assets pass to the charity.
OTHER FINANCIAL PLANNING CONSIDERATIONS
Planning for Retirement
It is a bit more challenging for unmarried couples to save for retirement. Social Security benefits go solely to the person earning them and there is no provision for the unmarried partner to receive partner benefits upon the death of the first-to-die partner. Most pension plans also do not allow benefits to continue to be paid to a surviving unmarried partner. An exception can occur if unmarried partners elect "term certain" payouts for named beneficiaries from the employer pension plan. A "term certain" payout election allows a beneficiary of a pension plan to receive a defined payment over a pre-specified, fixed number of years. However, this compromise arrangement is usually not as favorable as lifetime benefits that continue to a married surviving spouse. Nonetheless, unmarried couples may want to consider the "term certain" election if pension payouts are essential to maintain the standard of living of the surviving partner.
A surviving married spouse is allowed to roll over tax-free the deceased spouse's IRA balance and qualified retirement plan balance into their own IRAs. Unmarried partner beneficiaries of such retirement balances must take immediate lump-sum distributions and face the taxes due.
The following documents are particularly important for unmarried couples.
Wills: It is important that both unmarried partners prepare wills. Intestacy rule are not favorable (as previously discussed) to unmarried couples. The goal is to have a surviving partner receive the assets intended by the decedent.
Durable Power of Attorney: Such a power will allow a partner to sign papers and checks for an incapacitated partner and to take care of financial matters on his or her behalf.
Health Care Proxy: This proxy power (sometimes referred to as "medical power of attorney") allows a partner to speak on behalf of the incapacitated partner with respect to medical care decisions.
Living Will: This document instructs medical care providers of the patient's wishes regarding life support measures.
Unmarried partners should consider making the partner the beneficiary of life insurance policies. When there is a named beneficiary, the proceeds pass to the beneficiary and escape the probate process. Unmarried partners need to carefully plan the amount of life insurance needed. To continue the standard of living previously enjoyed as a couple, the unmarried couple may need more insurance than is usually recommended to single adults with no dependents that is, enough to cover final expenses and debts.
Legal Status Considerations
Every jurisdiction has extensive laws governing the marital relationship, but there are very few laws that govern couples living together outside of marriage. There are laws governing the common-law marriage. The mere fact that a heterosexual couple lives together is not sufficient to qualify as a common-law marriage. Residency and other qualifications must be met It is important for the financial planner dealing with unmarried heterosexual couples to understand the relevant state laws that govern the common-law marriage designation.
Although Canada, as of July 31, 2000, has granted same-sex relationships common-law status, an extension of that status to same-sex relationships has not been made in the United States. However, some laws are evolving that do address the marriage status issue for same-sex couples. On July 1, 2000, the Act Relating to Civil Unions (Act 91 [H.847]) took effect in Vermont. This statute provides eligible same-sex partners who enter a civil union the opportunity to obtain the same benefits and protections that Vermont law provides for married couples. Following Vermont's passage of the civil union statute, many states have responded by passing laws that limit the marriage relationship to a male and a female. Financial planners need to regularly update their knowledge of state laws impacting the issues facing unmarried couples in their legal jurisdictions.
TABLE 1 Demographic Information on the Number of Unmarried Couples per the U.S. Census (1)S. OPPOSITE-SEX SAME-SEX SAME-SEX UNMARRIED TOTAL COUPLE PERCENT OF ALL COUPLE YEAR HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS HOUSEHOLDS 2000 104,705,000 1,653,000 1.6 4,736,000 1995 98,990,000 1,684,000 1.7 3,668,000 1990 93,347,000 Not tracked N/A 2,856,000 1980 80,776,000 Not tracked N/A 1,589,000 1970 63,401,000 Not tracked N/A 523,000 1960 52,799,000 Not tracked N/A 439,000 OPPOSITE-SEX PERCENT OF ALL YEAR HOUSEHOLDS 2000 4.5 1995 3.7 1990 3.1 1980 2.0 1970 0.8 1960 0.8 TABLE 2 Contrast of the Availability of Wealth Transfer Strategies by Married and Unmarried Couples (4) WEALTH TRANSFER STRATEGY MARRIED UNMARRIED Lifetime Exemption $1 M Unified Tax Credit X X Unlimited Transfer (Marital Deduction) X Annual Exclusion of $11,000 per Recipient X X Gift Splitting X Intestacy Rules Favoring Partner/Spouse X Community Property X Living Trust X X Tax Free Gift of Income Interest to Spouse via QTIP X Unlimited Charitable Deduction X X Charitable Donations Through a CRAT X X Favourable Social Security and Qualified Plan Distributions After Death of Spouse/Partner X
(1.) http://www.census.gov/population/ww/socdemo/hh-fam.html and www.census.gov/population/socdemo/msda/tabad-2.txt.
(3.) The current exemption amount as provided by The Economic Growth and Tax Relief Reconciliation Act of 2001.
(6.) See discussion of intestacy laws at http://www.uslaw.com
(7.) See discussion of living trust at http://www.wwalw.com
(10.) Detailed requirements for CRATs exist under ss664 Regulations.
(11.) Adapted from a similar presentation online at http://www.efmoody.com/estate/commentary.html.
Jo Lynne Koehn, PhD, CFP, CPA, is Associate Professor of Accounting and Janice Klimek, PhD, CPA, is Assistant Professor of Accounting at Central Missouri State University Warrensburg, MO.
|Printer friendly Cite/link Email Feedback|
|Author:||Koehn, Jo Lynne; Klimek, Janice|
|Publication:||The National Public Accountant|
|Date:||Jul 1, 2002|
|Previous Article:||Effective marketing.|
|Next Article:||Marketing confessions of a financial advisor.|