Nine Financial Pitfalls Of Unmarried Couples
Avoid these top financial landmines
|Written by Tom Yeung, CFA | CDFA
Investment Advisor & Fund Manager, Jurnex Financial Advisors
What pitfalls should unmarried couples consider?
Cohabitation has become increasingly common in the US. According to the US Census, there are now 18 million Americans who live together without marrying.
But US tax, financial and marriage laws put unmarried couples at an enormous disadvantage. So in this article, I’m going to examine the nine financial pitfalls of unmarried couples.
As always, because family finance and tax advice is so personal, I recommend you reach out to a qualified advisor to make sure you’re on track. There’s no substitute for one-on-one help. But to get you started, here are the nine financial pitfalls of unmarried couples that you need to know.
1. Marital deductions
Marital deductions allow couples to transfer assets between each other, 100% tax-free. Unmarried couples, on the other hand, risk triggering gift taxes when they share or exchange property.
That’s because unmarried people can currently only transfer up to $15,000 every year to each other without triggering gift taxes. And gift taxes are surprisingly easy to trigger. Even adding people to your checking account or your house deed can be considered a gift by the IRS.
Actions that can trigger gift taxes
- Adding a joint tenant to real estate
- Loaning $10,000 or more
- Paying down someone else’s loans
- Adding someone to your investment account
To avoid triggering gift taxes, it’s advisable you contact a qualified tax specialist who can help you understand and navigate your particular situation.
2. Social security
Unmarried couples cannot claim the other person’s Social Security, potentially raising a big issue for those facing retirement.
To get more out of retirement, you have three options available.
1. Get married. You must be married for at least one year before qualifying for spousal Social Security. You also must be over the age of 62.
2. Save more for retirement. Alternatively, unmarried couples can save more in their retirement accounts in anticipation of self-funding retirement.
3. Domestic partner retirement benefits. Often, many companies offer equivalence in benefits to married and cohabiting partners. Check with your HR department to see if you qualify.
When selling a primary residence, individuals can exclude up to $250,000 of capital gains, saving thousands of dollars in taxes. Married couples can exclude double that amount, or $500,000.
But what if you’re unmarried and living together? Can you claim the $500,000 exemption? Here’s where things can get tricky.
If both partners have owned and lived in the home as a primary residence, EACH PERSON can exclude $250,000 of gains from their taxes. But this maneuver comes with certain caveats.
- Ownership. Firstly, both partners need to be on the house deed.
- Residence. Secondly, both partners need to have lived there for at least two of the past five years.
However, adding a partner can create gift tax and mortgage issues. And cohabitation often isn’t even a possibility for many unwed couples. So make sure you understand the full financial implications before co-owning a house.
If you’re considering buying property as an unmarried couple, applying for a mortgage can become yet another financial pitfall.
- Married couples. Typically, mortgage brokers prefer working with married couples if both have good credit scores. That’s because both incomes can get counted towards satisfying debt-to-income ratios.
- Unmarried couples. When it comes to issuing mortgages for unmarried couples, however, many mortgage brokers may see increased risk. What if one partner decides to leave the relationship or stop paying the mortgage? Because unmarried couples aren’t liable for each other’s debts, mortgage brokers are often hesitant to write loans despite laws that supposedly prevent discrimination.
What about applying for two separate mortgages for the same property? It’s harder to secure mortgages against properties that already have existing liens against them. The second mortgage (if you’re lucky enough to get one) will typically have a much higher interest rate and higher down payment requirements.
To address these issues, many cohabiting partners either decide to rent or have just one partner have the entire mortgage in their name.
5. Property titling
When unmarried couples choose to co-own property, they need to consider how to title the shared assets. Ownership can often be unclear, particularly if one party contributes more than another.
Create a “pre-marital” agreement
I usually recommend unmarried couples write a property settlement agreement before they start buying assets in joint name. The contract should outline how much each party will contribute and how the asset will get divided if the couple decides to leave.
Having a pre-written separation agreement can also help unmarried couples avoid paying gift taxes. The IRS spends significant resources in identifying taxable assets. And if the IRS decides to dispute the claim, it’s easier to prove that each party is retaining a clearly defined right to the property in question, even if it’s jointly titled.
6. Estate plan
Unmarried couples don’t qualify for next-of-kin laws, which can cause problems down the road.
Next of kin refers to your closest living blood relative. It’s an essential part of determining inheritance rights, especially if you die without a will. The laws differ by state, but they typically prioritize your spouse and then your children. If you don’t have either, state laws will usually default to your parents or grandparents as next of kin, and then to your siblings after that.
Assets: If you die without a will, your assets will typically get transferred to your next of kin.
So if you’re unmarried, you’re cohabiting spouse might end up with nothing if you die without a proper estate plan.
Rights: Hospital visitation rights are also an essential factor. If you become mentally incapacitated, next of kin laws can also apply for both visitation and power of attorney, depending on your state. Without the proper documentation, your partner might end up excluded from the decision-making and visitation process.
The essential list of documents for unmarried couples include:
- Durable Power of Attorney
- Health Care Proxy
7. Inheritance tax
Married couples can inherit unlimited amounts from a deceased spouse without triggering estate taxes. If your unmarried, however, these exemptions don’t apply.
That means your partner’s estate could be liable for paying a hefty inheritance tax. Federal rates can be as high as 40%, and state taxes can add another 10% tax on amounts above $5.49 million.
So what to do? By life insurance.
Fortunately, unmarried couples can reduce inheritance taxes with the smart use of life insurance. That’s because the IRS considers life insurance as non-taxable income.
In other words, if something were to happen to you, your partner will receive your life insurance proceeds tax-free.
It’s essential to choose an insurance policy that allows domestic partners. Policies can get voided if insurance companies determine you have no economic interest in the other person. This rule prevents people from taking out an insurance policy on people they’re not related to.
8. Health insurance
While some companies offer domestic partner benefits, many employers still don’t. Consequently, unmarried couples in this situation get forced to buy separate health insurance policies, raising healthcare costs by up to 50%.
And even for those that are eligible for domestic partner benefits, the premium paid to cover your partner is considered taxable income.
Also, be aware that the federal COBRA Act (Consolidated Omnibus Budget Reconciliation Act) doesn’t apply to unmarried couples. So if you leave your job, even though your employer legally must provide you with health insurance for 18 months, they’re not responsible for providing for your partner’s too.
To avoid this financial pitfall, make sure you’re budgeting enough for separate health care costs through life.
9. Auto and home insurance
Property and casualty insurance can be a landmine for unmarried couples. Many unmarried couples mistakenly believe their insurance policy covers a domestic partner when it does not.
Auto insurance. Whether or not you and your partner should share car insurance depends on several factors
- Driving safety record
- One partner has a poor credit score
- How often you use each other’s car
- Cost of each car
Home insurance. If your partner lives with you, but only one of you is on the house title or rental agreement, will insurance cover damage to the unlisted partner’s property? And if so, how much?
The financial pitfalls of unmarried couples can trip up even the most experienced tax accountants and financial advisors. So when you’re considering looking for good financial advice, make sure you find one that specializes in the life you live.
Where to find more resources
If this seems like a lot of information, don’t worry. The great news is that help is available. That’s because here at Jurnex, we work with individuals and families just like you to make the most out of investing. I’ve helped invest client money for over a decade in the same old-fashioned way. And that’s to seek out great companies in great industries that can you can buy at a discount to their fair value. Sounds too simple to be true? Give me a call today, and I’ll show you that it’s still possible after all these years.
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