How cohabiting can damage your wealth

Sam Barrett offers some practical tips on how unmarried couples can protect themselves.

Over the past two decades the number of couples living together without marrying has doubled from 1.5 million to 3.3 million. For many it is a positive lifestyle choice, but it can have a detrimental effect on their personal finances. Sam Barrett explains why and offers some practical tips on how unmarried couples can protect themselves.

More and more people are choosing to cohabit in retirement, and it’s among that older generation that the trend is growing most strongly. Government statistics show that more than 300,000 people over 65 are now living together rather than getting married, with the percentage of cohabitees in that age bracket up threefold since the turn of the century. However, while cohabiting may suit your lifestyle, it can seriously damage your finances.

Rules around inheritance, pensions and tax breaks tend to favour married couples. ‘A lot of people think they get “common-law spouse” status if they live together long enough, but this isn’t the case,’ says Helen Morrissey, personal finance specialist at Royal London. ‘If you’re cohabiting, there’s no automatic entitlement to your partner’s assets or benefits, however long you have lived together.’

Inheritance trap

Unfortunately, the tenuous nature of common-law status often isn’t appreciated until the death of a partner. If an unmarried partner dies without a will, the rules of intestacy ensure that their estate goes to children, siblings, half-uncles and even the Crown before their cohabiting partner.

You could stake a claim. Tasnim Khalid, partner and head of the wills, trust and tax team at JMW Solicitors, says that, under the Inheritance (Provision for Family and Dependants) Act 1975, cohabitees do have some rights. ‘A cohabiting partner can make a claim against the estate,’ she explains. ‘But it needs to be done within six months of the grant of probate and it can be an expensive process. Having a will in place is a much simpler option.’

-Inheritance tax payments hit highest ever level: how to reduce your bill

However, while a will ensures a partner is recognised without the need for any legal wrangling, it won’t afford them any special treatment when it comes to inheritance tax (IHT). Unlike married couples, who can leave their estate to one another IHT-free, cohabitees have to pay tax on anything over the nil rate band threshold (£325,000).

Property protection

This can potentially leave them in a very precarious position, especially where property is involved. Say, for example, you jointly own a property worth £1 million. When your partner dies, their half-share goes to you, but as this exceeds the nil rate band threshold, there will be IHT at 40 per cent to pay on the £175,000 excess – a bill of £70,000. ‘You can pay in 10 annual instalments but, faced with this sort of bill, a lot of people are forced to sell,’ says Khalid.

One way around this situation is to take out a whole-of-life policy written in trust. This can be used to settle the IHT liability and allow the surviving partner to continue living in a property. However, Jeannie Boyle, chartered financial planner and director at EQ Investors, says there are catches. ‘Whole-of-life policies can end up being very expensive. It’ll certainly cost a lot more than a registry office wedding,’ she explains.

The introduction of the residence nil rate band (RNRB) adds further complexity. This allows £100,000 of property per person (rising to £175,000 per person in 2020/21) to pass IHT-free to children and other descendants, to give the magical £1 million figure for a married couple when both nil rate bands are combined.

But as the nil rate band is only transferable between spouses and civil partners, cohabiting couples may have to weigh up the security of the surviving partner when deciding what to do. ‘When the kids own part of the property, it could be at risk in the event of their divorce or bankruptcy,’ says Khalid. ‘It may be fine to pass part of the property to an adult child married for years, but probably not to one on their seventh marriage.’

Private pension rights

As well as sorting out the estate and IHT liabilities, cohabiting partners can find themselves fighting for their other half ’s company pension. While there’s normally some provision for spouses and civil partners, this isn’t always the case for unmarried partners. ‘The more forward-looking pension schemes will recognise cohabitees, but it’s sensible to check scheme rules,’ says Clare Moffat, senior technical manager at Prudential.

She adds: ‘Sometimes differing criteria have to be met to receive a partner’s pension.’ These could include a minimum cohabitation period, confirmation that you were free to marry one another and some evidence of financial interdependence. ‘You might struggle to prove you were cohabiting if you have separate homes,’ Moffat adds. ‘Make sure you complete any expression of-wishes and nomination forms. They’re not legally binding, but they can help trustees determine where pension benefits should go.’

In this respect, there are signs, in the shape of the Brewster case earlier this year, that the position for cohabiting couples could soon improve. Denise Brewster was cohabiting with her partner when he died suddenly. As he hadn’t updated his nomination form, she didn’t have a right to his pension. However, she took the case to the Supreme Court and won, and this ruling could ease the way for other cohabiting couples.

While there’s some room for equal rights with occupational schemes, cohabiting couples can find themselves at a significant disadvantage compared with their married friends when it comes to state pension entitlement.

State pension rules

New pension rules, which apply to anyone reaching state pension age from April 2016, mean we now build up our own individual entitlement. State pension provision used to allow a wife or husband to inherit some of their late spouse’s pension rights. Morrissey says: ‘The old system was designed on the assumption that the man was the main breadwinner, so when he died, his wife got an uplift to her pension. On the basic state pension this uplift could be worth around £2,500 a year, while on the state earnings-related pension (Serps) it could be at least half of their spouse’s Serps pension.’

The new state pension provides some transitional relief for married couples. While this will disappear over time, it enables a surviving spouse, but not a cohabitee, to inherit half of any state pension in excess of the flat rate of £159.55 a week.

Tax breaks

Cohabiting couples also miss out on a number of tax breaks. The obvious one is the marriage allowance, which allows a married person to transfer £1,150 of their personal income tax allowance to their husband, wife or civil partner. Lee Clark, divisional director, financial planning at Brewin Dolphin, says: ‘One of you needs to be a non-taxpayer and the other a basic-rate taxpayer, but this scenario is more common among people in retirement.’

Not being married will also put you at a disadvantage in terms of capital gains tax (CGT). Married couples can transfer assets to each other freely without incurring CGT, allowing them to soak up profits of up to £22,600 between them in the current tax year.

Further bad news for cohabitees is that they can’t transfer their Isa allowances on death. Married couples and civil partners inherit the deceased’s Isa allowance, officially known as the additional permitted subscription, which will bump up their tax-efficient savings allowance by however much the deceased may have had in Isas when they died.

Insurance premiums

Insurance can cost you more if you decide to cohabit rather than marry. Although many insurers claim they don’t differentiate, a 69-year-old married woman insuring her car with Hastings Direct would pay £303.48 a year. If she cohabited, this would cost £341.89, with the insurer arguing that this is based on claims experience.

Unfortunately, weighting the system in favour of married couples is not out of line with government policy. Morrissey says this needs to change: ‘The government needs to recognise the trend towards cohabitation in tax and benefits legislation. The Cohabitation Rights Bill seeks to protect cohabiting couples, but as it has only had its first reading, there is still a long way to go.’

Until then, although you can protect yourself to a degree with careful planning, getting married really is the simplest way to secure a host of financial benefits. And providing you stay out of the divorce courts, with a registry office marriage costing just £120, it is likely to be the cheapest too.

Don’t want to put a ring on it? Five ways to protect yourself

Get a will: this is the simplest way to ensure a cohabiting partner is recognised, and avoid legal wrangling and family disputes.

Check pension scheme rules: complete an expression-of-wishes form to make trustees aware of your circumstances.

Use trusts: where children are involved, a trust can ensure both they and your surviving partner benefit from your wealth when you die. An interest-in-possession trust can allow your partner to remain in your home, even though it’ll go to your children on their death.

Consider life insurance: without access to IHT-free transfers, a whole-of-life policy can provide the funds to cover a future liability.

Draw up a cohabitation agreement: like pre-nuptial agreements, they’re not legally binding, but they may matter in court.

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