If marriage is not on the cards, what can you do to protect your estate?

Many cohabiting couples are under the misconception that they have legal rights as a so-called “common law spouse”. This term is often bandied about, but in fact has no legal meaning and a surviving cohabitant does not have an automatic right to inherit when one of them dies without a will.

The Government recently began a consultation process which may lead to the biggest shift in the law regarding cohabitation and could help protect couples who choose not to marry or enter a civil partnership.

A fairer end to relationships – what does the consultation suggest?

While the consultation considers reform of the law for cohabitants on both separation and intestacy, this article focuses on the proposed changes to intestacy (i.e. when a person dies without a will). In the consultation document, the Government suggests changing the intestacy rules to grant extra rights to the survivor of a cohabiting couple.

If a person does not have a valid will in place when they die, their estate (any assets capable of being transferred under a will or the intestacy rules) will be distributed in accordance with the intestacy rules. As the rules currently stand, there is no automatic right for the survivor of a cohabiting couple to inherit anything.

Broadly, the Government takes the view that “qualifying cohabitants” should have the same rights under the intestacy rules as married couples and civil partners and states that the proposed reforms are designed to provide greater protection for the economically weaker party on death. To qualify, a couple would essentially need to live together as husband and wife or civil partners for a set minimum amount of time prior to death.

However, this area is controversial as many people choose not to marry or enter into a civil partnership specifically to prevent their partner receiving any automatic rights to their estate on death. Therefore, the consultation asks if this is the best approach or if cohabitants’ rights under the intestacy rules should be narrower than those of married couples and civil partners. It also asks for opinions regarding the qualifying criteria, including the duration of the relationship and what, if any, impact having children together should have.

Although this move by the Government is exciting and may ultimately lead to better protection for those in long term relationships, we are unlikely to see any changes in the immediate future. For this reason it is still very important to consider what cohabitants can do to protect each other on death.

1. Why is a will especially important for unmarried couples who live together?

If the first cohabitant to die is survived by children, their estate will be given to those children outright at 18; if there are no surviving children, the estate will be given outright to the deceased’s parents (or, if they have also died, to the deceased’s siblings). Although the surviving cohabitant may be able to make a claim from the deceased’s estate under the Inheritance (Provision for Family and Dependants) Act 1975, litigation is intrinsically stressful and expensive.

By putting a will in place you are able to choose:
• Who will benefit from your estate and how
• Who will deal with your assets
• Who will act as guardians for any minor children

Cohabitants with valid wills in place should be aware that subsequent marriage or formation of a civil partnership will automatically revoke their wills unless the documents state that they are made in expectation of marriage or formation of a civil partnership.

2. Why do cohabitants need to carefully consider inheritance tax?

Cohabitants do not have the same inheritance tax (IHT) benefits as married couples and civil partners and as the recent consultation specifically excludes consideration of this issue, change is very unlikely.

Basically, IHT is charged on an individual’s estate on death at the rate of 40%. Each individual enjoys a nil-rate band amount (known as the “nil rate band”) which is taxed at 0%. The nil-rate band is currently £325,000 (less any gifts made in the seven years before death), so if you die leaving a £400,000 estate and have a full unused nil-rate band, IHT is charged at 40% on the £75,000 excess (assuming the additional IHT allowance “the residence nil rate band”, currently £175,000, is not available).

The principal IHT benefit available to married couples and civil partners is the “spouse exemption”. This allows one spouse to leave their entire estate to the other spouse free of IHT. In addition, any unused nil-rate band and residence nil rate band (if applicable) are transferrable between spouses. Therefore, on the first death a surviving spouse or civil partner can inherit completely tax-free and then potentially enjoy IHT allowances of up to £1 million when they subsequently die.

However, there is no spouse exemption available to an unmarried couple, and the unused nil rate band and residence nil rate band (if applicable) are not transferable between them.

So how can cohabitants pass on their estates tax efficiently?

Option 1: Will trusts

You can consider using a trust created by your will to ensure your chosen beneficiaries inherit your assets as you intend. For instance, you may have children, but want your partner to be able to continue living in the house you own. A trust structure allows your partner to be able to continue living in the property whilst protecting the underlying capital for the benefit of your children. It also prevents the value of the assets you want your partner to benefit from potentially aggregating with the value of their own estate and IHT being paid twice i.e. once on your death and then again on your partner’s subsequent death.

Option 2: Purchase life assurance

If you do not want marry or enter into a civil partnership, in consultation with your financial adviser you could consider purchasing life assurance and placing it in trust for the benefit of your partner (and/or children). This can be a useful tax planning tool. By placing the benefit of the policy in trust, the policy will not pay into your estate on death and will therefore not be subject to IHT. On your death, the trustees of the policy trust may pay the proceeds to your nominated beneficiaries. Your beneficiaries can then use these funds to settle debts, pay IHT or provide for themselves financially.

Option 3: Tax efficient investments

Your financial adviser will be able to advise you on tax-efficient investments designed to mitigate your IHT exposure.

The above options do not constitute legal or financial advice and, as each individual’s circumstances vary, we suggest you take advice on the options available to you. If you require advice about your estate planning matters, please contact info@ts-p.co.uk