Marriage vs. Domestic Partnership: Financial Pros & Cons
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Jane and John, in their mid-30s, have been together for 10 years. Although they refer to each other as husband and wife and are perceived as married by others, they are actually domestic partners. As domestic partners, they file taxes separately, which helps them delay moving into a higher tax bracket and potentially lowers their overall tax burden. While they enjoy financial flexibility and independence, their arrangement brings unique financial implications they need to navigate.
According to the U.S. Census Bureau, over 7 million unmarried couples live together in the United States. While being legally married or domestic partners involves much more than just finances, in this article, we will delve into the financial aspects of the two.
Key Takeaways
- The Tax Policy Center reports that the ‘marriage penalty’ can increase a couple’s tax burden by several thousand dollars annually, based on their income
- Domestic partnerships provide more financial flexibility and independence
- Domestic partners may not qualify for death, pension, or survivor benefits if one partner dies, depending on state regulations
- Each couple must weigh the financial pros and cons of each arrangement based on their unique circumstances and long-term goals.
- In California, registered domestic partners enjoy many of the rights that married couples have, including benefits like health Insurance, tax benefits, inheritance rights and medical decision-making rights
What is Marriage Tax Penalty?
Marriage penalties and bonuses arise because income taxes are typically calculated based on the combined income of married couples, rather than treating each spouse’s income individually. In a progressive tax system, the combined income of a married couple can result in higher or lower taxes compared to what two single individuals would pay separately. Although couples have the option to file taxes separately, choosing this route almost always leads to a higher tax burden.
Marriage penalties are more likely when both spouses earn similar incomes, while bonuses are more common when there’s a significant disparity in their earnings. Couples with children often face penalties because they cannot claim certain tax benefits, such as the head of household status available to unmarried individuals. Additionally, certain tax provisions tied to income levels can either mitigate or exacerbate marriage penalties or bonuses under specific circumstances.
| Financial Aspect | Domestic Partnership | Legal Marriage |
| Tax Filing | Partners file taxes separately, avoiding the ‘marriage tax’ penalty that affects similar-income married couples. | Couples file taxes jointly, which could push them into a higher tax bracket (marriage penalty) but might also qualify for joint tax benefits. |
| Social Security Benefits | Not eligible for spousal Social Security benefits. | Eligible for spousal Social Security benefits, enhancing retirement planning options. |
| Health Insurance | Each partner must find their own health insurance, potentially leading to higher costs. | One spouse can be covered under the other’s employer-provided health insurance, potentially lowering healthcare costs. |
| Estate Planning | Partners must create wills and possibly set up trusts to ensure their assets are transferred according to their wishes. | Spouses can transfer assets with fewer tax implications, benefiting from the unlimited marital deduction. |
| Legal Protections | Partners must establish power of attorney and healthcare directives to ensure decision-making rights for each other. | Spouses automatically have the right to make medical and financial decisions for each other. |
| Retirement Accounts | Partners cannot contribute to each other’s IRAs and must carefully designate beneficiaries. | Spouses can contribute to each other’s IRAs and have more straightforward beneficiary designations. |
So which one is best for you? The bottomline:
Choosing between marriage and a domestic partnership involves weighing financial pros and cons. Marriage offers tax, social security, and legal benefits but may include drawbacks like the marriage penalty and joint debt liability. Domestic partnerships provide more financial flexibility and independence but lack many protections and benefits of marriage. Couples should consider their unique financial situation and long-term goals when deciding.
When might a Domestic Partnership be better?
1. Significant Income Disparity
If one partner, like Jane, owns a successful business, a domestic partnership might help maintain financial independence and protect assets from potential risks associated with the other partner’s debts.
2. Family Business
A domestic partnership can potentially prevent legal claims to business assets, ensuring the business owner retains full control over decisions and assets.
3. Avoiding the Marriage Tax Penalty
Couples with similar incomes can avoid the higher tax burden associated with the “marriage tax” penalty by filing taxes separately as domestic partners.
Registered Domestic Partnerships in California
In California, registered domestic partners have most of the rights and responsibilities that married couples have including:
Health Insurance: Eligibility for partner’s employer-provided health insurance.
Tax Benefits: Joint state tax filing while maintaining separate federal tax filings.
Inheritance Rights: Domestic partners will inherit their partner’s assets by default if that partner did not have a will.
Legal Protections: Medical decision-making and hospital visitation rights
Advantages of being in a Domestic Partnership:
1. Individual Tax Filing
Separate Returns: Domestic partners can file taxes individually, which might be beneficial if there is a significant disparity in incomes. This can help lower the overall tax burden.
2. Separate Credit Scores
Credit Independence: Each partner maintains their own credit score, avoiding potential negative impacts from a partner’s poor credit history. This can be advantageous when applying for loans or credit cards.
3. Flexibility in Financial Arrangements
Custom Financial Structure: Domestic partners have more flexibility in structuring their finances and assets without the legal obligations imposed by marriage. This allows for personalized financial planning and asset management.
Financial Disadvantages of a Domestic Partnership
1. Limited Tax Benefits
No Joint Filing: Domestic partners cannot file taxes jointly and miss out on tax benefits available to married couples, such as the Earned Income Tax Credit and Child and Dependent Care Credit.
2. Lack of Social Security Benefits
No Spousal Benefits: Domestic partners are not entitled to spousal Social Security benefits, which can be a significant disadvantage in retirement planning. This includes survivor benefits and spousal retirement benefits.
3. Estate Planning Challenges
Estate Taxes: Domestic partners may face difficulties in estate planning, including potential estate taxes and challenges in asset transfer. Without the unlimited marital deduction, transferring assets between partners can be costly.
Inheritance Issues: Domestic partners do not automatically inherit each other’s assets, which can lead to legal disputes and potential exclusion from inheritance.
4. Healthcare and Retirement Limitations
Ineligibility for Spousal Coverage: Domestic partners may not be eligible for spousal coverage under employer-sponsored health plans, potentially leading to higher healthcare costs.
Retirement Account Restrictions: Domestic partners may face restrictions on retirement account contributions and benefits, such as the inability to contribute to each other’s IRAs.
Financial Advantages of being Legally Married
1. Tax Benefits
- Joint Filing: Married couples can file taxes jointly, potentially lowering their tax rate on combined income. This can be particularly beneficial if there is a significant income disparity between partners, allowing them to take advantage of lower tax brackets.
- Tax Credits and Deductions: Married couples have access to additional tax credits and deductions, such as the Earned Income Tax Credit (EITC) and the Child and Dependent Care Credit.
2. Social Security Benefits
- Spousal Benefits: Spouses are eligible for Social Security benefits based on their partner’s earnings, which can significantly boost retirement income. This includes spousal benefits, survivor benefits, and benefits for divorced spouses who were married for at least 10 years.
- Survivor Benefits: The Social Security Administration highlights that surviving spouses can receive up to 100% of their deceased partner’s benefits, a significant advantage not available to domestic partners.
3. Estate Planning
- Unlimited Marital Deduction: Married couples can transfer an unlimited amount of assets to each other without incurring estate taxes, which is not the case for domestic partners.
- Simplified Inheritance: Legal marriage simplifies inheritance processes, as spouses are often the default beneficiaries for retirement accounts, pensions, and life insurance policies.
4. Health Insurance
- Spousal Coverage: Many employers offer health insurance plans that cover spouses, often at a lower premium than individual plans. This can result in significant savings on healthcare costs.
- COBRA Benefits: Spouses are eligible for COBRA continuation coverage if they lose their job-based health insurance, providing a safety net during transitions.
5. Retirement Accounts
- Spousal IRA Contributions: Married couples can contribute to each other’s IRA accounts, enhancing their retirement savings potential. This is particularly beneficial for non-working spouses or those with lower incomes.
- Beneficiary Protections: Spouses are afforded special protections under ERISA (Employee Retirement Income Security Act), ensuring they are the primary beneficiaries of retirement accounts unless they waive this right.
6. Legal Protections
- Divorce Settlements: In the event of a divorce, legal marriage provides a framework for the fair division of assets and spousal support arrangements, offering protection and financial stability.
- Spousal Rights: Spouses have legal rights to make medical and financial decisions for each other in case of incapacity, which domestic partners might not automatically have.
Financial Disadvantages of being Legally Married
1.Higher Taxes
If a couple of similar income chooses to file taxes jointly, they might end up paying more in taxes. This is due to the progressive nature of the tax system, which can push the combined income into a higher tax bracket. However, there is an option to file taxes separately even though you might be married.
2. Joint Debt Liability
Spouses are often jointly responsible for debts incurred during the marriage. This can be problematic if one partner brings significant debt into the marriage or if financial mismanagement occurs.
3. Divorce Costs
Divorce proceedings can be lengthy and expensive, involving legal fees, court costs, and potential alimony payments. This can lead to a significant financial burden for both parties.
The division of assets during a divorce can be complicated and contentious, potentially leading to financial instability and disputes.
4. Loss of Benefits
Marriage can result in the loss of need-based benefits, such as student financial aid or Medicaid, as household income and assets are combined for eligibility assessments.
Next Steps for You
Being legally married can have a long lasting effect on your finances and well-being. While the decision should not solely be based on financial implications, there is no denying that it is an important aspect of the marriage contract. Consider speaking with a financial advisor and a legal professional to understand the full implications of each option based on your specific circumstances.
Regardless of your decision, make sure to plan for the future by setting up necessary legal documents, such as wills, power of attorney, and healthcare directives. Book a call below.
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