The ins and outs of domestic partnerships

Domestic partnerships and civil unions continue to be viable alternatives for many couples, regardless of sexual orientation, following the U.S. Supreme Court ruling on same-sex marriage.1

Domestic partnerships offer a different legal and financial arrangement than marriage. Marriage gives couples certain benefits around retirement, inheritance and insurance; however, domestic partnerships may need to take extra steps to achieve similar results, while facing different (but sometimes beneficial) tax implications.

So how do domestic partnerships compare to marriage from a financial standpoint?

Weighing tax benefits and burdens

When it comes to income taxes, domestic partners have the upper-hand, especially if both partners are high earners. That’s because of the so-called marriage penalty. Two high-earning spouses could pay more in taxes when they file jointly than they would if they were each single.

For married couples filing jointly, the 25 percent bracket ends at a combined income of $151,900 for 2016; for single filers, it’s $91,500 (and for a married person filing separately, it’s $75,950).2

So for example, spouses each making up to $91,000 in 2016 would be in the 25 percent tax bracket if they were single. But if those same people are married (with a combined $182,000 in earnings), they would land in the 28 percent bracket, whether filing jointly or separately.

The decision for married couples to file jointly or separately can be tricky. On one hand, filing jointly has the benefits of larger deductions and more credits. But couples must also consider the so-called marriage penalty, illustrated above—not to mention, the fact that for those who are married and filing separately, the brackets progress at a faster rate than single filers. There are a number of variables at play, so consulting a tax professional can help you figure out what’s best for your situation.

While unmarried couples may not benefit from the deductions and credits available to married couples, as single filers they can take advantage of relatively lower tax brackets than their married counterparts. Moreover, if they have children, the lower-earning partner can claim them as dependents, helping increase the likelihood of receiving financial aid for higher education.

But domestic partners are taxed in other ways like health insurance. If your employer offers health insurance benefits to domestic partners, the value of that perk is considered taxable income, which isn’t the case for married couples where coverage for spouses is tax-free.

Ensuring a secure retirement

Married couples benefit from the ability to roll over an inherited spousal IRA into their own IRA after the death of a spouse. That allows them to wait until age 70½ to start making withdrawals and start paying income taxes on that money.3

Domestic partners, on the other hand, must keep the inherited IRA and start taking required minimum distributions within a year or liquidate it within five years. Either scenario could force them to pay income tax on the money sooner than they might like.

And domestic partners do not have as many options to leverage the different Social Security strategies available to married couples.4 For example, widows and widowers are eligible to receive Social Security starting at 60, and they can receive half of the higher earning spouse’s benefit beginning at 62. A spouse with a lower monthly benefit can “step up” to a higher amount after the main breadwinner dies.

Domestic partners, therefore, should consult a tax professional to explore whether investing outside a qualified retirement account like a 401(k) or an IRA might offer more flexibility at retirement.

Taking care of the next generation

Married couples are able to potentially pass an unlimited amount of assets to each other at death. But domestic partners can only pass on $5.45 million—just like everyone else—before the estate is subject to the estate tax. Then, when the second partner dies, his or her estate will be taxed again for amounts above the $5.45 million threshold.

If your estate is large, a life insurance trust could keep the proceeds of the life insurance out of your estate. The money would pass to the beneficiary tax-free and be used to pay the estate taxes, helping to preserve the value of the estate for the surviving partner. Talk to a financial advisor to further explore such options.

While recent shifts in law may have changed the reasons for some to explore domestic partnerships and civil unions, these relationships still provide an important alternative to marriage. Though financial planning is more streamlined for married couples, domestic partners now have many of the same tools to create a secure financial future for themselves and their families.
 

1Leah Libresco. “Gay Marriage Doesn’t Make Domestic Partnership Obsolete.” Five Thirty Eight. Accessed March 3, 2016. http://fivethirtyeight.com/datalab/gay-marriage-doesnt-make-domestic-partnership-obsolete

2“Tax Brackets.” Bankrate. Accessed March 3, 2016. http://www.bankrate.com/finance/taxes/tax-brackets.aspx

3“Retirement Plan and IRA Minimum Required Distributions FAQs.” IRS. Accessed March 3, 2016. https://www.irs.gov/Retirement-Plans/Retirement-Plans-FAQs-regarding-Required-Minimum-Distributions

4Jane Bryant Quinn. “Maximize Your Social Security Benefits.” AARP. Accessed March 3, 2016. http://www.aarp.org/work/social-security/info-2015/maximize-social-security-benefits.html

Lincoln Financial Group® affiliates, their distributors and their respective employees, representatives, and/or insurance agents do not provide tax, accounting or legal advice. Please consult an independent advisor as to any tax, accounting or legal statements made herein.