BERLIN – As an unmarried couple, domestic partners have few of the protections or favorable tax treatments available to traditional married couples under state and federal estate tax laws. According to the Human Rights Campaign, it has been estimated that domestic partners do not enjoy over 1100 laws and regulations afforded married couples.
The “unlimited marital deduction,” for example, allows assets to pass from a surviving husband or wife free from federal estate or gift taxes. However, your domestic partner can only exempt up to $2 million — the current estate tax exemption — from federal estate taxes and $1 million over lifetime from gift tax. Amounts above $2 million are subject to aggressive federal estate tax rates of up to 46 percent, plus state tax where appropriate. The tax bite will become even more painful in 2011, when the exemption is scheduled to return to $1 million and the maximum federal estate tax rate will climb to 60 percent.
Unfortunately, we do not know if, or when, the benefits of the unlimited marital deduction will be made available to domestic partners. Still, domestic partners should ask the right questions and plan accordingly; financial advisors have many strategies at their disposal to help you and your partner minimize estate taxes and tackle additional financial strategies.
For example, consider a trust to reduce estate taxes, protect privacy and ensure that your wishes are carried out. A living trust allows partners to transfer title of assets to a trust during their lifetime—or upon death—through a “pour-over” will. Assets in a living trust can pass directly to the surviving partner, or remain in trust, without formal probate proceedings. You not only avoid probate but plan for a successor trustee (perhaps the partner) to manage assets in the event of your incapacity as well. You may also wish to consider strategic philanthropic planning which can create income and/or principal distributions to the surviving partner as well as help reduce estate taxes and support causes you and your partner both care about.
One of the best ways to make sure that retirement assets pass more tax-efficiently to your partner is to roll over 401(k) plan assets to an IRA. Employer-sponsored plans may require “non-spouse beneficiaries” to take taxable distributions immediately, which increases taxable income and reduces the amount that can grow tax-deferred over time. Although recent legislation allows for plans to be rolled into an “inherited” IRA and provide structured distribution over time, thereby spreading the tax liability over lifetime, there is no requirement that plans provide that option. By contrast, a rollover IRA allows domestic partners to distribute the assets over a period of years (aka a “stretch IRA”) so more of the inherited amount can grow on a tax-deferred basis for a longer time.
If you have not checked your beneficiary designations lately, make sure that you have named your partner, assuming it is your intent that your partner inherits the assets outright.
An estate plan is most effective when it is developed as part of an overall financial strategy that includes investment, retirement and insurance planning. Work with a financial advisor who can serve as a quarterback to manage the planning process and can recommend legal and tax professionals, if necessary.
(The writer is a Merrill Lynch Senior Financial Advisor. She can be reached at 410-208-9084.)