Insurance Issues That Concern Unmarried Couples
What insurance issues concern unmarried couples?
Although having adequate insurance is important for most couples, unmarried couples should particularly consider how life and health insurance can help them address the unique concerns they face.
Because you're not married, you're ineligible for many of the benefits the government, employers, and the tax code confer on married partners. Life insurance can provide a vehicle to address these concerns. It can replace income after the death of your partner, provide cash to pay estate taxes, and provide funds that avoid probate.
Health insurance may be an issue if your employer offers coverage under a domestic partner benefits plan. The value of coverage provided to your unmarried partner is taxable to you as income, unless your partner qualifies as a spouse under local law or a dependent under federal tax law.
Life insurance provides a vehicle to address special concerns of unmarried couples
Because you're not married, you're ineligible for many of the benefits the government, employers, and the tax code confer on married partners. For example, Social Security and defined benefit pension plans don't replace income for your partner after your death, as they do for a spouse. Tax laws don't shelter your estate, as they do for a married couple. However, life insurance can provide a vehicle to address these concerns.
Life insurance provides replacement income after a partner's death
As the surviving partner in an unmarried couple, you may face a greater financial burden in maintaining your standard of living after the death of your partner than does a surviving spouse. You may not be eligible to receive income from many sources that a spouse might, or you may receive only limited benefits.
Social Security does not pay survivor's benefits to unmarried partners. While you may be eligible to receive Social Security based on your own earnings, or that of a deceased former spouse or ex-spouse, you can't receive benefits based on your unmarried partner's record. In addition, defined benefit pension plans typically don't automatically offer benefits to a nonspousal beneficiary. A spouse, in contrast, is legally entitled to benefits under certain plans unless he or she waives that right.
Caution: You can receive distributions fromqualified retirement plans, such as401(k)s,403(b)s, andindividual retirement accounts (IRAs), provided your partner has named you as the beneficiary. However, spouses generally have more options when it comes to distributing or rolling over retirement funds — this presents a potential tax disadvantage for non-spouse beneficiaries. Life insurance provides a vehicle to provide replacement income to your partner. You can structure this by cross-owning life insurance policies or by purchasing an individual policy with your partner as the beneficiary.
- Cross-owning life insurance policies—You each buy a policy on the other's life. At your partner's death, you cash in the policy investing the proceeds to produce the income you need. Because the policy was not your partner's property, the proceeds of the policy are not included in his or her estate, and thus is not subject to federal estate tax. However, the value of the policy your partner owns on your life is included in your partner's estate for tax purposes.
Example(s): Shawn and Max are an unmarried couple. They each buy a life insurance policy on the other. When Shawn dies, Max invests the proceeds and lives off the interest. Because Max owns the policy, the proceeds paid upon Shawn's death are not included in Shawn's estate and thus not subject to federal estate tax when he dies. However, the value of the policy Shawn owns on Max's life is included in Shawn's estate for estate tax purposes.
You may need to demonstrate an insurable interest to purchase life insurance on each other. Married couples are assumed to have an insurable interest. Couples who own a house or business together are also considered to have an insurable interest, although only up to the value of their shares of the mortgage or business. You can prove insurable interest by providing evidence of jointly owned assets and, possibly, copies of your wills or trust documents.
- Individual policy with your partner as beneficiary—You own your own policy, naming your partner as beneficiary.
Caution: Because this policy is your property, it is included in your estate when you die. Any amount over the estate tax applicable exclusion amount may be subject to estate taxes.
Example(s): Shawn owns a policy, naming Max as the beneficiary. When Shawn dies in 2007, the proceeds of the policy are included in his estate. Because Shawn's estate is valued at $2.1 million, the amount over $2 million is taxable at the applicable tax rate of 28 percent (assume no other variables). Shawn's estate owes $23,800 in estate taxes, significantly cutting into the amount available to Max.
Life insurance provides cash to replace wealth lost due to estate tax
Federal tax laws permit every individual to leave an estate worth up to the amount of the applicable exclusion amount. Any amount over that limit is taxed at rates that range from 18 percent to 45 percent (in 2007). Some states also impose their own estate taxes.
Married couples, however, enjoy a special tax break called the unlimited marital deduction. This allows them to transfer as much as they want to each other free of estate and gift tax (though any amount so transferred must be taxed on the death of the second spouse). Because you are not entitled to the unlimited marital deduction, anything you leave your partner above the applicable exclusion amount is subject to federal estate tax. Some states also impose their own estate taxes. Life insurance provides a vehicle to generate cash that is available to replace the wealth lost due to estate taxes. You can structure this through an irrevocable trust, or you can cross-own life insurance policies.
- Create an irrevocable trust—You set up a trust, managed by a trustee, that buys and owns a life insurance policy. You provide funds to the trust to pay the premiums.
Tip: Because the trust owns the policy, the proceeds are kept out of your gross estate.
Caution: You can transfer an existing policy to the trust, but if you die within three years of the transfer, the value of the policy will be included in your gross estate for estate tax purposes. An irrevocable trust must be set up carefully to avoid adverse tax consequences. It is costly to set up, and, as its name implies, it cannot be revoked once it's been established.
- Cross-own life insurance policies—You each buy a policy on the other's life to cover the estimated estate tax. Because this policy is not your partner's property, the cash value at the date of death is not included in his or her estate, and thus is not subject to federal estate tax. However, the value of the policy your partner owns on your life is included in your partner's estate for tax purposes.
Example(s): Sydney and Rudy are an unmarried couple and the beneficiaries of each other's estate. They each buy a life insurance policy on the other. When Rudy dies in 2007, if her estate is valued at $2,025,000, the difference in excess of $2 million is taxed at the 22 percent applicable tax rate for a total of $4,900 (assume no other variables). Rudy's estate pays the taxes due. The life insurance is available to replace estate wealth lost due to taxes.
Life insurance proceeds avoid probate
If a beneficiary other than your executor or estate is named, life insurance proceeds don't go through probate. Because of this, life insurance offers a way to provide for your unmarried partner without the complications of a will. Some of the advantages of avoiding probate are: (1) the funds are immediately available at death and (2) the distribution is not as likely as a will to be contested by relatives who may disapprove of your relationship.
Health insurance issues
Domestic partner benefits are taxable
Health insurance may be an issue if you're eligible for coverage under your partner's domestic partner benefits plan. A growing number of employers now offer benefits to the unmarried partners of employees. Often, the most important benefit is health insurance. However, the value of coverage provided to your unmarried partner often is taxable to you as income.
Caution: Because domestic partner benefits raise your taxable income, they may also increase your Social Security, Medicare, and state taxes.
Weighing costs versus benefits of domestic partner health coverage
If your employer offers health insurance to your unmarried partner, you may want to do a cost/benefit analysis before signing up. First, estimate the annual cost by adding the out-of-pocket cost to the additional taxes. Second, weigh this against the benefits of the policy to determine if this is a good deal for you and your partner.
Example(s): Pat and Terry are domestic partners. Pat works, while Terry rears the children. When Pat's employer, BigCo, Inc., begins offering health benefits to domestic partners, Terry considers signing up. Being a savvy couple, Pat and Terry calculate a rough estimate of the total annual cost before making a decision.
|Step 1. ||They estimate the annual out-of-pocket cost as follows: ||
| ||Assume the premiums for Terry are ||$600
| ||+ Estimated deductibles/co-payments for doctor visits ||+ 60
| ||+ Estimated deductibles/co-payments for medication ||+ 30
| ||= Total estimated annual out-of-pocket cost ||$690
|Step 2. ||They determine Pat's additional tax per year as follows: ||
| ||BigCo, Inc.'s share of the premiums ||$1200
| ||x Pat's tax on BigCo's contribution* ||x .28
| || = Total additional tax per year for Pat ||$336
|Step 3. ||They add the estimated annual out-of-pocket cost ||$690
| ||+ to Pat's additional tax per year ||
| ||= Total estimated annual cost of Terry's health benefits ||$1,026
|(*Pat's tax rate is 28%; yours may differ)|
Example(s): Pat and Terry now see that the true cost of Terry's health insurance is $1,026 per year (the out-of-pocket cost plus the taxes), not $690. After examining the plan and feeling satisfied with its coverage, and knowing he can't get a better deal purchasing insurance elsewhere, Terry decides to enroll despite the additional tax. However, if Terry can purchase acceptable insurance on his own for less than $1,026 per year, or if the plan offers only limited or poor coverage, Terry may decline enrollment and search for coverage elsewhere.
Comparing costs of coverage under a domestic partner benefits plan to your own employer's plan
Another situation you may face is that your employer offers health insurance and your partner's employer offers domestic partner benefits. How do you know which is the better deal to take? In this case, compare the annual cost of each plan before selecting coverage. You may find that the additional tax on the domestic partner coverage outweighs the benefits.
Example(s): Terry returns to work at Ace Company, which provides health benefits. Terry compares the annual cost of health benefits at Ace to the yearly cost under Pat's domestic partner benefits plan at BigCo as follows:
| ||Ace Company||BigCo
|Terry's annual share of the premiums||$800||$600
|+ Estimated deductibles/co-payments for doctor visits
|+ Estimated deductibles/co-payments for medication||$30||$30
|+ Pat's additional tax per year||$0||$336
|= Total estimated annual out-of-pocket cost for Terry||$890||$1,096
|Total annual savings under Ace's plan: $1,026 - $890 = $136
Example(s): Even though Terry's annual premiums are higher at Ace Company ($800 compared to $600), the total yearly cost is $136 lower because he and Pat avoid paying the tax on the domestic partner benefits. Since the coverage under both plans is comparable, it's a better deal for Terry to enroll in Ace's plan.
Enrollment and continuation of coverage concerns
Before enrolling for domestic partner health insurance, especially if you also have the option of signing up for coverage through your own employer, ask whether the Consolidated Omnibus Budget Reconciliation Act (COBRA) applies to your coverage. This may vary by insurer.
If you decline coverage now, you may be able to enroll during the next open enrollment period. Check with the employer providing the coverage.
RPS is a registered investment advisor for Virginia, Maryland,
the District of Columbia. This web site is not a solicitation to sell
investment advisory services outside those areas, except where such
registration is not required. This site is for information only and
should not be construed as a vehicle to deliver advice for any investor
or individual. RPS delivers advice only after we provide clients a
copy of our registration document (FORM ADV) and our contract has been
executed. Information throughout this site pertaining to market or
other financial data is obtained from sources that RPS considers reliable.
RPS does not warrant or guarantee the timeliness or accuracy of this
References made to investment or portfolio performance are based on
historical data, and there is no guarantee of such performance in the