When New Jersey’s same-sex marriage ban was struck down last year, two of accountant James Wood’s clients were ready to join the rush to City Hall. His advice? Wait.
Why? One of the same-sex partners had just adopted the other partner’s child, and if they got married in the same year, the new parent would lose an adoption tax credit of up to $12,970.
“That’s one situation in which domestic partners have a unique advantage over married couples,” explains the Hillsborough, N.J.–based CPA. “Married couples don’t qualify for the tax credit when one spouse adopts the other spouse’s children.”
This is just one of the myriad unique challenges—and opportunities—domestic partners face with their financial planning, Wood says. Key among them is the fact that partners, whether of the same or opposite sex, lack many of the legal rights that are automatically granted to spouses in the event of divorce or death.
So if you’re in a domestic partnership, or considering one, you and your loved one should plan a little more carefully in these five financial areas to protect each other both financially and legally.
Here’s one bit of good news: Probably the single biggest advantage unmarried couples have over their married counterparts is greater flexibility in filing their income taxes, Wood says. “The marriage penalty doesn’t apply to domestic partners, so they can do substantially better from a tax perspective by filing as single heads of household."
For example, if you own a home with your domestic partner, you can choose to split deductions evenly or assign them to the partner where it is most beneficial. Or you can decide from year to year who will itemize the tax deductions allowed for your joint household, such as mortgage interest or real estate taxes, and who will take the standard deduction based on his or her individual income. This is particularly attractive for couples in which one partner is the primary breadwinner, because it allows them to pay fewer taxes than would a married couple. “And domestic partners can do even better if they have children together,” he says.
Here’s how: Consider an unmarried couple with two children. Since they have no legal standing as a couple, each person can claim one child and file as head of household, enjoying all the itemized deductions or credits that may come with having a child. Or you can mix and match. If one partner makes a lot more money than the other one in a given year, he or she can claim both children and take the itemized deductions. If the roles are reversed the following year, the two partners can switch off. “As long as they are both the legal parents, they can transfer deductions to take the best advantage of the tax code,” Wood says.
One downside to all this flexibility with taxes, though, is just researching all your options, and it’s a good idea to work with a tax professional to figure out what combination of deductions and credits can work for both of you.
2. Estate Planning
Tax time is pretty much where the advantages end for domestic partners when it comes to most things financial, says Diane Pearson, CFP®, a wealth manager and shareholder with Legend Financial Advisors in Pittsburgh. Without the inheritance rights that legally married couples have, all the rest of the financial planning for domestic partners should start at the end: with the estate plan. In other words, every decision should be based on how you want to provide for your partner should something happen to you. “So it’s really important to spend the time and energy necessary to make sure you get this right,” she says.
If you want to leave anything to your domestic partner, first make sure he is named in your will. With married couples, the surviving spouse usually gets the deceased spouse's assets even if there is no will (though this depends on state laws, too). But a domestic partner is less likely to inherit his partner's assets upon death unless he's specifically named in a will.
As far as estate taxes go, unless you’re a multimillionaire, assets passed from your estate to your domestic partner should be free from federal tax. That’s because the unified tax credit enables you to gift more than $5 million over the course of your lifetime (or at death) to someone else without having to trigger hefty estate taxes. Most people never expect to surpass that amount.
But remember that the exemption is just for federal taxes—many states have their own inheritance taxes. “In Pennsylvania the estate tax is currently 15% if you’re not related,” Pearson says. “That’s a pretty hefty tax bill, so you have to understand what the laws are in your state.”
3. Owning Property
One way to help make sure that your partner still retains ownership of your home together should something happen to you is to title real estate under both your names. This might also help avoid estate taxes and probate later. But, even this can be tricky, because different states may have different ways they legally define joint ownership—which, in turn, can create different inheritance scenarios.
For example, some states define joint ownership as “joint tenancy in common,” while others use “joint tenancy with right of survivorship.” Under joint tenancy with the right of survivorship, both partners own 100% of the asset, and the home’s title is transferred automatically to the surviving partner if the other dies. Under tenancy in common, each person owns a share of the asset. So if one partner dies without a will that leaves their share of the home to the surviving partner, the deceased person’s next of kin would inherit it. “You have to understand how these rules are worded in your state,” Pearson says.
Insurance companies have come a long way in recognizing domestic partners for medical, dental and life insurance, and most companies don’t require documentation that proves the domestic partnership. “Many employers allow domestic partners to be covered in their group plan, so it’s important to understand what your options are, especially if you are considering changing jobs,” Pearson says.
Also, some long-term-care insurance underwriters give domestic partners the spousal discount if both people are purchasing a policy from the same insurance company at the same time, Pearson says.
5. Retirement Savings
Some welcome changes to both defined benefit plans (pension plans that promise you a monthly benefit upon retirement) and defined contribution plans (retirement plans like IRAs and 401(k)s to which you contribute) have made it easier for unmarried couples to get their partner’s retirement benefits in the case of their death.
If you’re lucky enough to work for an employer with a pension plan—which is nearly a thing of the past, so good for you—many of them now allow you to name a beneficiary who isn’t your spouse if you choose a joint survivor benefit. That means your partner can continue receiving benefits if you die first. The downside is that joint survivor benefit payouts are typically much smaller than if you had chosen a single-life payout, which is when only the employee receives the benefits until his or her death.
A better option may be to consider taking the lump-sum distribution from your pension at retirement and put it into an IRA, Pearson says. The reason why an IRA might be better is because under recent changes, non-spousal beneficiaries are now allowed to roll over the deceased's IRA into an inherited IRA. This means that your partner is basically opening a new IRA account under her name and inheriting your savings (although she can’t add more to the IRA herself). In the past, non-spousal IRA beneficiaries had two choices: Take a lump-sum distribution immediately from the account or withdraw all of the assets of the deceased person’s savings within five years. Either choice could potentially trigger big tax hits. (Deciding whether to do a lump-sum distribution of a pension plan or receive a monthly payout, with or without a joint benefit, depends on a lot of factors in addition to availability of an inherited IRA, so chat with a professional!)
If you both have a 401(k) through your work, you can name each other as the beneficiaries to your accounts. Just make sure that if one of you is separated (but not divorced), your ex has signed a waiver—otherwise he will have legal claim to that money.
Unfortunately, when it comes to Social Security benefits, domestic partners are out of luck—the Social Security Administration does not currently recognize domestic partnerships, so unmarried couples don’t have spousal rights to their partner’s payments. If you were counting on a spousal Social Security benefit to cover a chunk of your joint expenses in your retirement, you and your partner may need to save more for retirement than married couples would in order to make up that difference should one of you pass away. (Domestic partners can still collect Social Security based on their own earnings records. It’s just that if one partner doesn’t work, they won’t be able to take advantage of the spousal benefit that entitles the non-working spouse to 50% of the amount their working spouse receives. This generally affects only couples with a large income disparity.)
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Without a marriage certificate, all of the moving parts and changing legislation can make it difficult to keep unity within the family unit. Knowing the laws—and enlisting the help of financial planners, tax advisers and estate attorneys—can help make sure that you and your loved one can navigate the maze together.
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