Financial Planning for Unmarried Couples
Author: Jennifer Climo
Financial and tax planning advice is relatively easy to find online for married couples and single individuals. However, according to the U.S. census, about 8% of adults live with an unmarried partner. When you are living with a long-term partner, you may think of yourself as married for most purposes, but the law treats you very differently than it does a married couple. It is important to understand these differences, as they can have a dramatic impact on your lifetime taxes paid.
It used to be that if you were LGBTQ+ and in a relationship, you were going to be an unmarried couple, as the federal government did not recognize same-sex marriage. This all changed in 2015, when gay marriage was made legal by a Supreme Court decision. However, many LGBTQ+ couples were long disgusted by the lack of marriage equity and chose to remain unmarried even after the court decision. This means there are still many unmarried LGBTQ+ couples.
Ironically, if you are not married, you are considered “single” in the eyes of the law. You may have been with your life partner for 30 years, but for the purposes of state and federal laws, you are considered single. It is a myth that if you live together long enough, you are common-law married.
There are lots of financial planning implications for unmarried couples. We are going to discuss five of them:
- Income tax rates
- IRA/qualified retirement plan inheritance
- Health Savings Account (HSA) inheritance
- Social Security
- General inheritance rules
Income Tax Rates for Unmarried Couples
It is relatively easy to find the difference in ordinary tax rates between married couples and single individuals. The tax brackets for married couples (at least, under current tax law) generally are double that of a single individual, until you get to the highest tax bracket. Take two single individuals with taxable income of $150,000 each, the standard deduction and no kids. They will pay $30,021 each in taxes, for a total of $60,042. A married couple with $300,000 in taxable income under those same assumptions will pay $59,592 – roughly the same.
The marriage advantage comes into play when one member of the couple makes a high income. If one member of the couple earns $50,000 in taxable income and the other $250,000, they will pay $68,798 ($6,754 + $62,044) in combined income taxes vs. $59,592 (from above).
Inheriting an IRA from an Unmarried Partner
Spouses are allowed special tax treatment when they inherit IRAs, Roth IRAs or other qualified retirement plans. In general, the surviving spouse can add the account balance to their own and avoid being required to take distributions (and being taxed on them) until their normal required beginning date, now age 72.
Anyone else who inherits one of these accounts, unless an exception is met, must empty the account by the end of the 10th year after the year of death.. They don’t have to take a distribution or be taxed on the account until that 10th year, but that would mean a potentially very large addition to income in that 10th year, potentially pushing them into a much higher tax bracket.
Exceptions to the 10-year rule include distributions to:
- the surviving spouse of the plan participant or IRA owner;
- a child of the plan participant or IRA owner who has not reached majority;
- a chronically ill individual; and
- any other individual who is not more than 10 years younger than the plan participant or IRA owner.
Beneficiaries who qualify under these exceptions may generally still take (and be taxed on) their distributions over their life expectancy (which was the rule in effect for deaths occurring before 2020). This is known as “stretching” the IRA.
The significant exception listed above that applies to unmarried couples is the last one, “any other individual who is not more than ten years younger than the plan participant or IRA owner.” This means that if you are 52 and your significant other (unmarried) is 45 and you pass away, your partner can stretch the payments over their life expectancy, which generally saves taxes because they are limiting the amount they are adding to their income each year. Presumably, this also works even if the ages are reversed – you are 45 and your significant other is 52 – because the beneficiary is not “more than 10 years younger.” This rule was likely intended for siblings who inherit but clearly also applies to unmarried partners.
It’s important to note that either of these rules applies only to designated beneficiaries (that is, those identified on a properly filed beneficiary form while you are still alive). If you neglect to name a beneficiary on your IRA account, then the account generally has to be emptied (and taxed) within five years, regardless of who inherits it.
Inheriting an HSA
HSAs are a terrific savings vehicle. Contributions to HSAs result in tax deductions, distributions from HSAs are tax-free if used for qualified medical expenses and HSAs grow income-tax free. HSAs inherited from a spouse can be added to the survivor’s account, continuing the tax-free treatment. If one member of an unmarried couple (or anyone who isn’t a spouse) inherits an HSA, they are taxed on the full amount that year. This can be an unwelcome surprise at tax time for the unwary, and unmarried couples may want to focus their retirement savings meant to benefit the survivor into a different type of account, such as a Roth IRA, Roth 401(k) or regular investment account.
Spouses can collect 50% of their spouse’s Social Security full retirement age benefit, or 100% of what they were collecting as a surviving spouse. Unmarried couples do not have any such benefit. When one member of the couple dies, their Social Security stops (unless they have minor children, but that is beyond the scope of this blog). This means that an unmarried couple’s decision of when to collect Social Security focuses on the size of the individual benefit, not on the potential survivor benefits.
While the higher-earning spouse in a married couple may decide to wait until age 70 to collect benefits so their spouse can collect a higher benefit for their lifetime, the higher-earning spouse in an unmarried couple may collect between full retirement age (age 67 for those born in 1960 or later) and age 70, depending on their life expectancy.
These decisions are different if there are minor children in the household, but that is a topic for a future blog post.
General Inheritance Rules
Married couples can inherit from each other even if no estate planning was done and there are no named beneficiaries on any accounts. While I wouldn’t suggest this lack of planning, most states have what is known as an “elective share” rule for spouses. How much that is depends on whether the individual who died has surviving parents or children and whether the children were also children of their spouse. As an example, this is the spouse’s share in New Hampshire. However, this method of inheriting also must pass through probate, which means you may be waiting months or years for access to your funds.
Unmarried members of a couple have no such protection. It is especially important for you to name a beneficiary on every asset you have if you are an unmarried couple or you could end up unintentionally disinheriting your life partner.
Isn’t a Will Enough Protection for Heirs?
A will is the least desirable way to inherit anything. That is because a will must pass through probate, which is expensive, public and time-consuming. You will be waiting months or years for access to your inheritance if you are relying solely on a will. In addition, IRAs or qualified accounts inherited through a will are treated as if there were no named beneficiary and must also pass through probate and be emptied (and taxed) within five years.
This is why we encourage people to add beneficiaries to all their accounts (retirement, brokerage, bank/savings, HSA, etc.) and establish a revocable trust to hold any assets where a beneficiary cannot be named (such as real estate in many states).
The primary purpose of a will is to catch any assets that you forgot or otherwise were not able to name a beneficiary and to name a guardian for your minor children. It can also be used for bequests, but a revocable trust may be a better vehicle for this.
Unmarried couples have few protections when it comes to benefits, taxes and inheritance. It is especially critical for unmarried couples to name beneficiaries on all their financial accounts, consider a revocable trust for nonfinancial assets and understand the income tax implications of inheriting different types of assets.
This is not to be considered investment, tax, or financial advice. Please review your personal situation with your tax and/or financial advisor. Jennifer Climo, CFP®, CPA, MSFP is an advisor at Milestone Financial Planning, LLC, a fee-only financial planning firm in Bedford NH. Milestone works with clients on a long-term, ongoing basis. Our fees are based on the assets that we manage and may include an annual financial planning subscription fee. Clients receive financial planning, tax planning, retirement planning, and investment management services, and have unlimited access to our advisors. We receive no commissions or referral fees. We put our clients’ interests first. If you need assistance with your investments or financial planning, please reach out to one of our fee-only advisors.