What Does This Article Cover?
For non–traditional families, especially unmarried couples, when it comes to passing on assets to loved ones, it's important to pay attention to details, specifically beneficiary designations. Without proper beneficiary designations to make sure your assets are distributed to the people and organizations you want to receive them, the disposition of your estate could be left up to a court or some relative you or your partner barely know. Whether it's life insurance, IRAs, retirement plans, or health care decisions, unmarried couples must not only formally make their wishes known, but also occasionally file additional documents not required for traditional married couples. It's important to take the time to be sure your intentions are clear are and revisit those decisions every few years to make sure they align with your current situation.
First Step: A Will
When it comes to passing along property, everyone needs a will. Without one, unmarried couples in particular are playing without a safety net, while traditional married couples have some built in assurances. For example, if a married person dies without a will all of the assets pass to the surviving spouse. For a non–traditional couple, the surviving partner receives nothing, unless it is indicated in a properly drawn up will. It is vital that non–traditional couples designate each other as beneficiaries in their wills. If they don't, when one of them dies, the assets may be distributed by probate court according to the laws in their state.
It's also a good idea to update a will periodically to show your continuing intent to pass along assets, as the original will states. To prevent anyone from contesting a will, partners may want to include a no–contest clause. This clause provides that any person contesting the will receive nothing. In most cases, it makes sense to leave a bequest to a person who may have an interest in contesting the will, so that person has something to lose by challenging the will. If privacy is important, a pour–over will can be used to protect the identity of actual beneficiaries.
IRAs, Retirement Plans, and Life Insurance
As important as wills are, they do not cover beneficiary designations for such important assets as IRA's, 401(k)s, pensions, or life insurance. Be familiar with all your various financial vehicles that have beneficiary designations and make sure they match your current wishes.
Again, different rules apply for married and unmarried couples. For example, for married couples, a spouse may treat her departed spouse's IRA as his/her own. She can roll it over into her own account and easily continue the IRA's tax deferred status. Unmarried couples do not have that luxury. First, an unmarried partner is not entitled to their deceased partner's retirement account unless he or she is specifically designated as the beneficiary.
Even then unmarried partners cannot simply rollover the IRA into their own accounts. Instead, they are limited by strict distribution rules that do not allow them to take advantage of an IRA's tax deferred benefits. Non–spouses must take distribution and pay tax on the IRA. There are two ways this can be accomplished.
No later than December 31 of the fifth year following the IRA owner's death, non–spouse beneficiaries must cash in the IRA without penalty, pay ordinary income tax and keep the balance.
Non–spouses can also have the IRA proceeds paid out over their own life expectancies and pay ordinary income tax on the amount distributed each year. This method must be selected no later than December 31 of the year following the IRAs owner's death.
Similar to IRAs, a surviving spouse is not entitled to receive any portion of the deceased partner's retirement account unless specifically designated as the beneficiary. If their retirement plans permit, unmarried partners can name each other as beneficiaries of their 401(k) plan, 403(b). Also, the assets may be subject to estate taxes at the death of the first partner. For all beneficiary designations it is a good idea to have the designation witnessed by a disinterested third party who, should it be necessary, can testify to the designating party's intent and capacity.
Life insurance can fulfill a number of needs for unmarried couples. First and foremost it can be used to pass on assets while maximizing estate tax savings. The surviving partner can use the proceeds to pay off a mortgage, cover living expenses, or pay estate taxes. Life Insurance proceeds can also be used to help supplement the surviving partner's retirement and provide significant replacement income.
Life insurance companies will not allow you to name a beneficiary for whom you do not have an insurable interest. Unmarried couples may have difficulty proving an "insurable interest," that is, that the surviving partner would be hurt financially by the death of the other partner. A written domestic partner agreement can often satisfy this requirement. Another solution used by many non–traditional couples is to transfer ownership of the policy either directly to the intended beneficiary or to an irrevocable trust, which prevents the insurance proceeds from being included in the estate itself and then subject to tax. Always check with your attorney, tax advisor, and estate planning professional to make sure your policies are structured properly.
There are three types of commonly used trusts:
An Irrevocable Crummey Trust: Under this trust, one partner of the couple makes gifts of up to $11,000 per year to an irrevocable trust to benefit the other member. The trust includes special Crummey powers that enable the gift to qualify for the $11,000 annual gift tax exclusion. The gifted property is removed from the transferee's estate because it is held in trust.
Another tax planning trust that works well for non–traditional families is the Grantor Retained Income Trust (GRIT). With a GRIT, the trust is funded with financial assets and the donor retains the rights to the income for a certain number of years after which it is transferred to the other partner.
A similar trust can also be used to transfer property. If the goal is for the surviving partner to retain the residence after the death of the partner who owns the house, a Qualified Personal Residence Trust (QPRT) can be do the trick. The owner transfers the residence to the QPRT. The donor retains the right to live in the residence for a specified number of years, after which it transfers to a trust to benefit the other partner.
In addition to beneficiary designations, there are other documents that can help non–traditional couples insure their wishes are met.
When it comes to making sure a surviving partner can maintain his/her residence after the death of one partner, make sure the house is owned as joint tenancy with the right of survivorship. Then the survivor will automatically own 100% of the property and avoid probate court. One potential drawback is that the transfer could be construed as a taxable gift and trigger a large tax bill. As with all of these issues and potential solutions, please consult with a qualified tax attorney to make sure.
Health Care Partners in unmarried couples usually have no rights to make health care or financial decisions for each other unless they take the proper steps. A well–constructed estate plan will include an advanced healthcare directive (ACHD) and a durable power of attorney. With an ACHD, a partner can oversee a partner's medical treatment and make decisions on their behalf if he/she is unable to do so. With a power of attorney, a partner can make financial decisions and maintain the home or business if the other partner is incapacitated. Without those key documents, non–spouses will not be able to make those decisions.
At no charge to you, a New York Life agent —professionally trained and experienced — can help you with your beneficiary designations for your life insurance, IRAs and retirement plans. They can also help you analyze your life insurance and retirement planning needs and work with your other advisors and tax attorney to recommend appropriate solutions through financial products and concepts. Click here to request a no–obligation review with a New York Life agent.
Neither New York Life nor its agents are in the business of offering tax, legal or accounting advice. Please consult your own professional advisors for tax, legal, and accounting advice.
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