Insurance Issues That Concern
Unmarried Couples
What insurance issues concern
unmarried couples?
In general
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.
Caution: State insurance laws vary--an insurance professional in your
state can give you more information about state laws that may affect your
insurance coverage.
Life
insurance
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 potential estate taxes, and provide funds that avoid probate.
Health
insurance
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 from qualified retirement plans,
such as 401(k)s, 403(b)s, and individual 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 nonspouse beneficiaries.
Life insurance provides 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 collect the policy's death benefit and
invest the proceeds to produce the income you need. Because your partner did
not own the policy, the proceeds will not be included in his or her estate for
federal gift and estate tax purposes. However, the value of the policy your
partner owns on your life is includable in your partner's estate for federal
gift and estate tax purposes.
Example(s): Shawn and Max are an unmarried couple. They each buy a life
insurance policy on the other. When Shawn died, Max invested the proceeds and
now lives off the interest. Because Max owned the policy, the proceeds paid
upon Shawn's death were not included in Shawn's estate and were not subject to
federal gift and estate tax when he died. However, the value of the policy
Shawn owned on Max's life was included in Shawn's estate for federal gift and
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--You own your own policy, naming your partner as beneficiary.
Caution: Because you own the policy, it is includable in your estate when
you die for federal gift and estate tax purposes. Any amount over the
applicable exclusion amount may be subject to the tax.
Example(s): Shawn owned a policy, naming Max as the beneficiary. When Shawn
died in 2014, the proceeds of the policy were includable in his estate. If
Shawn's taxable estate exceeded the applicable exclusion amount (in this case,
$5,340,000), the excess would be subject to gift and estate tax beginning at a
rate of 18 percent up to 35 percent. The potential tax liability on Shawn's
estate (which includes the value of life insurance he owned at his death, could
have significantly cut into the amount available to Max.
Life
insurance provides cash to replace wealth lost due to transfer taxes
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 35
percent. Some states also impose their own transfer 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 federal gift and estate tax (though any
amount so transferred may 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 may be subject to federal gift
and estate tax. Some states also impose their own transfer taxes. Life
insurance provides a way to replace the wealth lost due to transfer 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 on your life. 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 for federal gift and estate tax purposes.
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 includable
in your gross estate for federal gift and estate tax purposes. An irrevocable
trust must be set up carefully to avoid adverse tax consequences. It can be
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 potential transfer taxes. Because your partner does not own the policy,
the cash value at the date of death is not includable in his or her estate for
federal gift and estate tax purposes. However, the value of the policy your
partner owns on your life is includable 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, the policy Sydney owned on Rudy's life pays death proceeds to Rudy,
the policy's beneficiary. Rudy can use the life insurance proceeds to replace
estate wealth lost due to transfer 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, on
the federal level (but not in all states), 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.
(*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:
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.
CornerStone Financial
Whether your
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Contact:
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President/CEO
CornerStone
Financial
(615) 427-8780
IMPORTANT DISCLOSURES
The
information presented here is not specific to any individual's personal
circumstances.
To the extent
that this material concerns tax matters, it is not intended or written to be
used, and cannot be used, by a taxpayer for the purpose of avoiding penalties
that may be imposed by law. Each taxpayer should seek independent advice from a
tax professional based on his or her individual circumstances.
These
materials are provided for general information and educational purposes based
upon publicly available information from sources believed to be reliable—we
cannot assure the accuracy or completeness of these materials. The information
in these materials may change at any time and without notice.
