Essential planning for unmarried couples

Many people hold the belief that an unmarried partner attains various rights as a ‘common law spouse’ after living long term with their other half. However, there is in fact no such concept in UK law. The reality is that couples who are neither married nor in a civil partnership have very limited rights on death or separation, no matter how long they have lived together or whether or not they have children.

There has been a significant increase over recent years in the number of couples living together, without formalising their relationship in such as way. It is essential people are aware of the position and undertake the planning to mitigate the unfavourable potential outcomes. The following article touches on a number of areas to consider for such couples and illustrates the importance of putting suitable arrangements in place.

The Importance of having a Will

If a person dies without a valid Will, their estate will be distributed in accordance with the Intestacy Rules, which impose a strict order of priority as to who is entitled to their estate. Under the current Intestacy Rules, a surviving spouse is entitled (sometimes in part) to the estate of their deceased partner, whereas an unmarried partner does not have any automatic rights, potentially leaving them in a very vulnerable position. If a couple do not have children, then if one of them were to die their estate will pass to the deceased's surviving parents (and if they have both died, to any siblings). If, however, the couple have children, those children will have an automatic entitlement under these rules; but this will not be of direct benefit to the surviving partner, particularly if the children are from a different relationship.

The position for the survivor is improved if any of the assets are owned by the couple as joint tenants, such as a property. Such assets will pass automatically to the survivor on the death of the first partner irrespective of the Intestacy Rules. However, the best way for unmarried partners to avoid the consequences and potential injustice of the Intestacy Rules is to ensure they both make a Will documenting their wishes.

The Inheritance Tax (IHT) position

Even if unmarried couples have suitably drafted Wills in place, the IHT position can be problematic. Any transfers of property or assets between couples who are married or in a civil partnership (whether on death or during lifetime) benefit from the spouse exemption. This has the result that there will be no IHT payable upon the death of the first spouse, regardless of the value their estate.

By comparison, unmarried couples do not benefit from the spouse exemption in relation to the assets which are gifted on death or during lifetime by one partner to the other. Therefore, an IHT charge at a flat rate of 40% will arise on any assets held by the deceased, in excess of the available nil rate band for IHT purposes, currently £325,000. This can cause considerable issues, such as the family home needing to be sold to settle an IHT charge on the first death.

In addition, unmarried couples do not benefit from the transferrable nil rate band provisions. For couples who are married or in a civil partnership, on the death of the surviving spouse, these rules allow the nil rate band to be 'uplifted' by the relevant portion of the nil rate band which was unused on first death. For cohabiting couples, if the nil rate band is not used on the death of the first partner, perhaps due to the fact that they do not have sufficient assets in their estate, this part of the nil rate band will be lost and not available to offset the value of the estate of the surviving partner. It may therefore be beneficial for such a couple to equalise their assets during their lifetime.

A further valuable IHT relief is the residence nil rate band (RNRB) which provides a benefit if a couple have children. Often the RNRB is transferable to the survivor's estate, being unused on the first death, as the entire estate passes to the survivor. However, if a couple were not married or in a civil partnership, the first RNRB is not transferable.

Furthermore, for unmarried partners there can be situations where no RNRB will be available at all: for instance, where one partner has children, but the other does not. If the parent of those children dies first and leaves their entire estate (either outright or under a life interest trust) to the surviving partner, then no RNRB is available on the first death as the property will not be deemed to have been 'closely inherited'. On the death of the survivor, even if their estate passes to those children, no RNRB (or indeed any transferable RNRB) will be available at all. This is because the legislation dictates that those children would only be recognised as 'stepchildren' if there had been a marriage or civil partnership, or if they had been adopted by the surviving partner.

In view of the fact that a couple who are neither married nor in a civil partnership do not benefit from the spouse exemption, any assets which pass through both estates will potentially be subject to a double charge to IHT. This potential ‘double charge’ could be avoided if the Will of the first partner is suitably drafted, by the incorporation of a discretionary trust of the residuary estate. Such a structure would not affect the IHT position on the first death, however, an IHT saving would be achieved on the second death. Although the surviving partner could be a beneficiary of the discretionary trust, the assets of the trust would not form part of their taxable estate on their subsequent death, thereby achieving an IHT saving at this point.

Capital Gains Tax (CGT)

When married couples or civil partners make lifetime gifts to each other, there are significant CGT reliefs available as such gifts are made on a 'no gain, no loss' basis. This means that the there is no immediate CGT charge, and the recipient instead takes the gift at their spouse's original purchase cost. Conversely, for unmarried couples there is no such relief available, and CGT could be chargeable on lifetime gifts between them.

Life Insurance arrangements

If a life insurance policy is payable to the deceased's estate it will be subject to IHT, even if the deceased's Will provides that it passes to the surviving unmarried partner. In the case of a married couple such an arrangement would benefit from the spouse exemption, thereby avoiding an IHT charge.

If, however, the policy is written in trust, one of the beneficiaries of which could be the unmarried partner, an IHT charge could be avoided provided the arrangement was structured correctly. Furthermore, doing so can lead to extra IHT efficiency, as steps can be taken to ensure that such amount does not form part of the surviving partner's estate, thereby shielding those funds from being exposed to IHT on the future death of the surviving partner.

Pension death benefits

The majority of private pension lump sum death benefits are paid at the discretion of the scheme trustees. Typically, a surviving spouse would have an extremely strong claim to receive any such lump sum. Conversely, although cohabiting couples may have a claim if they can prove they cohabited for a minimum qualifying period, such a right to benefit from their late partner's pension is not automatic and it is very important to ensure they are named formally prior to death as a 'nominated beneficiary' using an expression of wishes form.

Because any such sums are payable at the trustees' discretion, they are currently not normally subject to IHT as part of the deceased's estate. Such payments can be of significant value, and once they are paid to the survivor, they will form part of their IHT estate upon their later death. In certain circumstances, pre age 75, it can be more IHT efficient for the payment to pass to a suitable trust structure which will then shelter the payment from IHT on the survivor's death.

During the recent budget, however, the government announced plans that most pension benefits that pass on death, will be subject to IHT from 6 April 2027. Whilst these proposals are subject to a consultation process which ends in January 2025, as things currently stand, no IHT is payable to benefits passed to a surviving spouse due to the spouse exemption. Benefits passed to an unmarried partner may be subject to IHT. This could have significant financial implications for the remaining partner, especially if retirement plans were primarily funded via the pension of the deceased partner.

State pension

As for the state pension, married couples and civil partners are at an advantage here too, as a surviving spouse or civil partner may well be entitled to an enhanced basic pension following the death of their spouse. However, such provision does not extend to couples who are not married or in a civil partnership.

Cohabitation agreements

In cases of relationship breakdown unmarried couples have very limited rights. In view of this it is advisable to have a cohabitation agreement in order to cover the financial position of the parties if the relationship fails. A cohabitation agreement outlines clearly each partner's responsibilities, the patterns of ownership in various assets, their respective expectations from owning property, and their intentions on what should happen if the relationship were to end. The courts can enforce such agreements as they are regarded as binding contracts between unrelated parties.

Conclusion

In this brief article we have considered some of the areas couples that are neither married nor in a civil partnership should be aware of and have highlighted the importance of putting into place appropriate arrangements to protect their position and improve tax efficiency of their planning. If you would like to discuss the points covered in this article in more detail, please let us know.