The traditional family ain't what it used to be.
According to the 2000 U.S. Census, there has been a sevenfold increase in the number of unmarried households in the United States over the past 30 years, including an estimated 14 million gay and lesbian couples and an estimated 12 million single-parent families. Together, these “nontraditional” families comprise a large market — one that is largely underserved by estate and financial planning advisors.
This article will present four steps to a properly planned estate for a client in a nontraditional family.
Understand the planning benefits of marriage.
The recent decision of the Massachusetts Supreme Court to recognize marriage between same-sex partners has led to renewed interest in the legal benefits of marriage. It is true that marriage provides a number of legal benefits that are not available to unmarried couples and singles, perhaps the most important of which is the unlimited estate- and gift-tax marital deduction that allows spouses to make unlimited transfers between each other without any tax consequence.
For example, many married couples have “I Love You” wills in which they simply leave their entire estates to one another, without even giving a thought to whether there might be a tax consequence. And these couples are right not to worry about taxes: As a result of the unlimited estate-tax marital deduction, spouses can leave unlimited amounts to one another and avoid all federal tax. By contrast, if one member of an unmarried couple transfers property to the other member of the couple, either during life or at death, the transfer will be subject to the federal estate or gift tax if it exceeds the available estate- or gift-tax exemption. As a result, an “I Love You” will between two members of an unmarried couple could result in a federal estate tax at rates up to 48 percent when the first member of the couple dies.
Marriage also confers a number of additional tax and nontax benefits. The additional tax benefits of marriage include the ability for spouses to split gifts, the absence of any income tax on transfers between spouses and the ability for a surviving spouse to roll over an IRA received from a deceased spouse and defer taxation of the account until age 70 1/2. The nontax benefits of marriage are also significant. These include the right for spouses to inherit a certain amount from one another in the absence of a will, the right of a spouse to a certain minimum portion of a deceased spouse's estate — even if the deceased spouse's will purports to disinherit the surviving spouse, the right of a spouse to a minimum share of a deceased spouse's retirement plans and the asset-protection benefits of holding real estate between spouses as tenants by the entirety. None of these benefits is available to members of an unmarried couple.
Establish a prudent transfer tax plan.
As noted, unmarried couples face the prospect of an estate tax when the first member of the couple dies. There are two responses to this problem. First, the couple should consider prudent methods for reducing the size of each member's taxable estate through various gifting strategies. Second, if gifting is not advisable or feasible, each member of the couple should consider the purchase of life insurance on his or her own life to pay any tax that may be due. The insurance should be owned by an irrevocable life insurance trust in order to avoid having the insurance proceeds themselves included in the insured's taxable estate.
There are many different gifting strategies that might be considered in the nontraditional family context. Three common examples are the Irrevocable Crummey Trust, the Qualified Personal Residence Trust and the Grantor Retained Income Trust.
Under an Irrevocable Crummey Trust, one member of the couple would make gifts of up to $11,000 per year to an irrevocable trust for the benefit of the other member of the couple. The trust would include special provisions known as “Crummey powers,” which would qualify the gift for the $11,000 annual gift-tax exclusion. The gifted property would be removed from the transferor's estate (because he had given the property away). In addition, the gifted property would be removed from the transferee's estate because it would be held in trust rather than owned outright by the transferee. The transferor could also use such a trust as the repository of a gift utilizing the transferor's $1,000,000 gift-tax exempt amount. This would remove the income and appreciation on the gifted property from the transferor and transferee's estates.
Special planning can be undertaken for any residence used by the couple but owned by only one member of the couple using a Qualified Personal Residence Trust (QPRT). The owner of the residence would transfer the residence to the QPRT. Pursuant to the terms of the trust, the donor would retain the right to live in the residence for a certain period of years, after which ownership of the residence would pass to a trust for the benefit of the other member of the couple. If the trust is designed properly, certain provisions of the Internal Revenue Code allow the donor to discount the value of the gift to the trust to reflect the actuarial value of the transferor's retained use of the property.
Another transfer tax-planning device that should be considered in a nontraditional family situation is the Grantor Retained Income Trust (GRIT). This is an irrevocable trust much like a QPRT, but instead of being funded with a residence, the trust is funded with financial assets. And, whereas in a QPRT the donor retains the right to use the transferred residence for a period of years, in a GRIT, the donor retains the right to the income from the gifted property for a certain period of years. Like the QPRT, the GRIT allows the donor to take the position that the value of the gifted property should be discounted to reflect the donor's retained right to use (i.e., to take the income from) the gifted property. The GRIT is one area in which nontraditional families actually have an advantage over traditional families. As a result of a 1990 law, the discounting advantage of a GRIT is eliminated if the beneficiaries of the GRIT are closely related to one another.
Establish a proper will or living trust agreement.
For members of a married couple, the lack of a proper will is not often an all-out disaster. If one spouse dies without a will, the surviving spouse will be entitled to a significant portion of the estate under most states' laws. Such laws do not apply to provide this kind of protection, however, for members of unmarried couples. Accordingly, it is critically important that each member of such couples has in place a well-constructed will directing the disposition of his or her property at death. In some families, blood relatives of the deceased member of the couple may not have known about and/or approved of the relationship between the deceased and the surviving member of the couple and may challenge the will. Accordingly, the will can include a “no contest” clause that disinherits any person who challenges the will. (The validity of these clauses is not recognized in all states.)
Members of an unmarried couple should also consider a revocable living trust agreement. A will is a public document and it is relatively easy for a member of the deceased's family to locate, read and challenge. A revocable living trust agreement, on the other hand, can be a private document and, therefore, may be less likely to be subject to a legal challenge at death as a practical matter.
Ensure that appropriate planning has been done for incapacity.
Members of an unmarried couple generally have no right to make health care or financial decisions for one another or even to visit each other in the hospital. A well-constructed estate plan provides each member of the couple with a living will, an authorization to obtain the other member's private health care information in the event one member of the couple is ill and a power of attorney authorizing the other member of the couple to make financial decisions.
It is possible that blood relatives of an incapacitated member of an unmarried couple might seek to have the power of attorney set aside by a court. If that were to occur, the court could appoint a conservator to manage the incapacitated individual's personal and financial affairs. A well-constructed estate plan will include an Advance Designation of Conservator. Typically, the Advance Designation would designate whomever is named as attorney-in-fact under the power of attorney as conservator. Then, anyone challenging the power of attorney would know that the only result of their challenge would be the appointment of the individual named as attorney-in-fact to the position of conservator.
Nontraditional families are a growing, yet underserved, segment of the estate-planning market. The techniques described above provide financial planners and advisors with the relevant estate-planning strategies necessary to protect nontraditional families.