Overcome Tax, Pension Disadvantages

Over the last decade the legalization of gay marriage in several states has given rise to a steady increase in the number of same-sex couples who are seeking custom approaches to fulfill their insurance needs.

As same-sex marriages are not recognized under federal law, these couples are precluded from reaping the maximum benefits. Proactive planning is a huge asset to any same-sex couple wishing to use insurance benefits to their greatest potential.

Not eligible

The federal Defense of Marriage Act (DOMA) prevents same-sex couples who might be legally married under state law from being recognized as married for federal income tax and estate tax purposes. Each spouse must file his or her own federal income tax return. Therefore, the couple cannot combine incomes and deductions to take advantage of lower tax rates and the benefits that can accrue from balancing profits and losses in financial transactions.

Traditional spouses can pass on unlimited assets to each other without estate tax consequences both during their lifetime as well as at the first spouse’s death. Same-sex couples must pay estate taxes on any amount exceeding $2.25 million in 2013. (The amount is adjusted for inflation, annually.)

Additionally, the surviving partner is not entitled to receive Social Security survivor’s benefits or corporate pensions-and that’s perhaps the biggest reason why same-sex couples often need more life insurance than traditional couples. And when a same-sex couple has children, the need for insurance is even greater.

Possible policies to compensate

Purchasing life insurance can reduce the impact of these tax and pension consequences. By cross-insuring each other, a couple can compensate for missing out on traditional benefits by providing tax-free income to a surviving partner.

Term insurance, the least expensive form of life insurance, is usually guaranteed for 10-, 15-, 20- or 30-year periods. As long as both partners are healthy enough to qualify, many life insurance companies will allow same-sex partners to acquire term insurance with their life partner as their beneficiary. If both partners cross-insure by acquiring term insurance on the other, it can serve as a fairly uncomplicated and inexpensive way for the lower earner of the couple to replace the income that would be lost if the higher earner dies.

A single-life universal policy is a permanent insurance policy that accumulates cash value. This can be a preferable plan for same-sex couples because it can provide coverage for the insured up to age 121. As with all life insurance, the death benefit will be paid tax-free to the beneficiary or beneficiaries. It is another option for same-sex married couples who want their respective spouses to be able to maintain a certain lifestyle following a death.

A survivorship universal life policy (second-to-die) pays a death benefit to the beneficiary after both of the spouses have passed. For traditional married couples this can be used to pay estate taxes or provide a legacy to their heirs or a charity.

However, a survivorship policy may not be suitable for same-sex couples because, since the couple isn’t legally married under federal law, the first insured’s estate may be taxed immediately as it transfers to the survivor after the first death. The exception to this would be if the assets of both spouses are below the estate tax threshold. This factor is what really drives the motivation for choosing a survivorship policy over a single-life product over the other.

Generally speaking, a $2 million survivorship policy costs approximately 30% less than two individual $1 million policies. Second-to-die policies also include clauses or riders that provide for the right to split the policy into two individual ones.

Whether choosing term, universal life or second-to-die insurance, same-sex couples must be both educated and proactive and must know the specific goals they are trying to achieve with the sought-after coverage. Having an advisor who’s knowledgeable about the special financial challenges of same sex couples can make a real difference.

Todd Sandstrom is a plan design specialist with Longfellow Benefits, a Boston firm that offers employee and executive benefits. He can be reached at tsandstrom@lf-ben.com.