By Mike Anderson
When a 65-year-old man legally adopts his 73-year-old partner because they have no other way to protect their estate from inheritance taxes, something is wrong.
John and Gregory have been together since the late 1960s. Now entering their golden years, they’ve begun preparing their finances for when one of them passes. To minimize their tax liability, John adopted Gregory, the older of the two, changing their legal relationship to father and son—and irrevocably so, even if Pennsylvania legalizes gay marriage.
Through the adoption, they’ve decreased their inheritance tax from 15% to just 4.5%—which is still 4.5% more than it would cost a straight couple.
Marriage equality is banned in thirty-five states. John and Greg live in one of them—Pennsylvania. The Keystone State waives the inheritance tax on transfers to surviving spouses and children aged 21 or younger. Transfers to direct descendants are taxed at 4.5%. Transfers to siblings are taxed at 12%. All other transfers are taxed at 15%.
Because Pennsylvania will not recognize a marriage between John and Greg, adoption was the most effective way to protect their estate. If one of them leaves behind $500,000, the adoption would reduce the inheritance tax from $75,000 to $22,500.
Steps to protecting your inheritance High taxes are just one of the major challenges homosexual couples face when securing an inheritance. They also need to navigate our legal system to guarantee the relatively inexpensive transfer of a home and to ensure that all assets end up in the right hands.
Paperwork. A 2009 New York Times article estimated gay couples might spend $5,500 more than straight couples in financial planning paperwork, and that’s a conservative estimate. Some couples spend over $10,000 more to secure their assets.
Here are several documents that can help set up a proper inheritance in states where gay marriage is not recognized:
1. Will: A will is a good place to start to control the distribution of your property and assets.
2. Revocable living trust: More difficult to contest than a will, a living trust transfers property to one or more beneficiaries in the event of a trigger event—usually a death. It also can save your beneficiaries time and money because, with a living trust, assets are transferred without court supervision.
3. Pour-over will: Most transfer only their largest assets to a living trust. A pour-over will, then, is its complement: it guarantees that all other assets be poured into the trust and then transferred to your beneficiaries. Before these particular assets are transferred, however, they go into probate and therefore are subject to probate fees.
4. Financial power of attorney: A crucial document, a financial power of attorney designates an individual who is to act as a financial agent in the event of incapacitation or death.
If you are without the necessary documents, state law will dictate the distribution of your property. In states where marriage equality isn’t recognized, this can put assets in the hands of family members who might not have the couple’s best financial interest at heart.
Homeownership. Though a will can guarantee the surviving partner takes over full ownership of their shared home, the transfer will be subject to state inheritance tax. If, for example, two men living in Pennsylvania share ownership of their house, then the surviving partner will have to pay 15% on half the house’s value in order to take on full ownership.
To avoid inheritance tax on a home, a couple might consider joint tenancy, which allows property to pass automatically to the surviving partner without probate. If one of the tenants dies, the other takes on full ownership of the property.
Other methods. Some experts suggest loading up on life insurance—which is tax-protected—or transferring assets before death to avoid high inheritance taxes.
Transferring assets before death can be tricky, as you essentially place bets on who is going to kick the bucket first.
Mike Anderson is an analyst for NerdWallet, a financial-literacy company dedicated to helping consumers make better decisions with their wallet.