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How cohabiting couples can limit potential financial disadvantages

Cohabitation is the fastest-growing family type in the UK, but an unmarried couples legal and financial rights are complex, confusing and widely misunderstood.

As many as two-thirds of cohabiting couples are unaware of their lack of rights, as reported in a recent survey by family justice organization Resolution. This lack of rights has serious financial consequences for cohabitants and their families.

At the beginning of the relationship

Cohabitants are at an immediate financial disadvantage in comparison with married and civil-partnered couples from the day they move in together, primarily as a consequence of various allowances being unavailable to them.

For example, the marriage allowance, worth £238 a year, is specifically designed to reward marital over cohabitation status.

A spouse who does not use their full personal tax-free allowance may transfer up to £1,190 of their personal allowance in the current tax year to their tax-paying spouse or civil partner.

Similarly, married and civil-partnered couples can share assets between them to take advantage of their personal savings and dividends allowances, while reducing any capital gains tax liability on assets held jointly by combining their gains allowance.

By contrast, a transfer of property between cohabiting couples means an immediate capital gains tax charge at 20 per cent or 28 per cent. However, the challenges faced by cohabiting couples become much more pronounced on the breakdown of a relationship.

What if the relationship breaks down

Although it is possible to make these claims, it can be difficult and draining both financially and emotionally, and a fair outcome is not always guaranteed.

A mother can find that she is not legally entitled to any share in the family home if the property has been purchased in her partner’s name and she has not made contributions to the mortgage.

Even if she seeks to stay in the family home for the sake of the children, she will be required to leave the property once the children have reached adulthood. Unlike spouses or civil partners, she cannot apply for maintenance for herself.

Yet this might not be the most costly injustice facing cohabiting couples. Cohabitants and their families are at an even greater disadvantage on the death of each partner.

If a cohabiting couple split up, the biggest source of contention is likely to be the ownership of the home they shared.

With no process analogous to divorce available, complex property case law has developed, enabling the non-owning cohabitant to claim a share in the property most commonly by demonstrating a beneficial interest in the home.

If this is not documented, which is often the case, significant financial contributions must be demonstrated: for example, by making the mortgage repayments and by showing there was a joint intention that would result in them having an interest in the property.

If a partner dies

A cohabitant has no automatic rights to their partner’s estate, making wills especially important for cohabiting couples. If one partner dies without making a will, that partner’s children or family members, if they have no children would inherit everything. The bereaved partner has only limited rights to claim what would be reasonable for their maintenance.

The disadvantage that cohabitants and their children face when it comes to inheritance tax (IHT) is perhaps even more egregious. No IHT is levied following the death of a married or civil-partnered person, if the estate is passed to his or her spouse.

The beneficiary will then inherit their partner’s unused IHT allowance, enabling them to leave an estate worth up to £900,000 to their children before incurring IHT, assuming the estate includes a main residence valued at £250,000 or more.

In 2020, where an estate includes a home valued at £350,000 or more, the figure will increase to £1m before IHT is levied.

In contrast, IHT is levied when wealth and property worth £325,000 or more is passed from a cohabitant to his or her partner, with no additional threshold available for a main residence.

IHT is then levied once again when that partner leaves the estate to their children if the estate is worth £325,000 or more, or £450,000 if it includes a main residence valued above £125,000. This means IHT is potentially levied twice and from less than half the threshold of a married couple on the combined estate of a cohabiting couple.

Depending on how wealth is split between the cohabiting couple and the order in which they die, beneficiaries can lose out to the tune of several hundred thousand pounds in comparison with what they would have inherited had the couple been married.

Cohabitants also lack the rights enjoyed by married or civil-partnered couples to inherit their partner’s Isa investments without losing the tax break on their cash.

A similar situation exists when it comes to pensions. Company pension schemes allow married and civil-partnered couples to name their spouse or partner as a beneficiary should they pass away, entitling the widow or widower to receive a yearly sum from the pension scheme on their partner’s death.

Under defined pension death benefits, the surviving spouse or civil partner typically gains 50 per cent of the deceased’s pension. The lack of a survivor’s pension for cohabitants means that globally billions of pounds are not being paid out as no claims can be made.

To offset these complications, especially for occupational schemes, cohabiting couples can submit an expression of wish form to their pension scheme naming the cohabiting partner as the beneficiary upon death. Although not legally binding, this is a good way to inform a pension scheme where the benefits should go upon death.

Meanwhile, bereavement benefits are restricted to married and civil-partnered widows and widowers, and most existing state pensions for older pensioners are boosted following the death of a spouse, but surviving cohabitants do not have the same rights to benefit. It is likely that these disadvantages have led to a recent upsurge in death bed marriages involving urgent hospital applications for marriage licences.

What is the solution?

While cohabiting couples face some significant disadvantages compared with married or civil-partnered couples, there are things they can do to limit the impact this has on their lives.

In particular, a cohabitation agreement can prove invaluable for cohabiting couples by setting out who is entitled to what if the relationship breaks down. It can establish what each will contribute towards household expenditure and the actions that would trigger the end of the relationship.

Similarly, when buying a home together, couples may wish to enter into a declaration of trust an effective and legally binding agreement which sets out in what shares the property is owned.

Cohabitants currently find themselves in an awkward place legally and financially. The Supreme Court decision in the McLaughlin case very much highlights the difficulties this can cause for everyday families. Policymakers seek to restrict and at times deprive cohabitants of tax advantages and other financial benefits available to those who are married. The intention is to incentivize marriage, but the effect is to penalize the children of the fastest-growing family type in the UK.

While uncertainty, misunderstandings and complexity continue, it is inevitable that there will be more challenges to the current law. As public awareness continues to rise, and following the landmark Supreme Court decision, inevitably greater pressure is being put on parliament to ensure the fiscal system is fair for all modern families.

In the meantime, prudent financial and legal planning on a proactive basis is recommended with frequent reviews when changes in the law impact on unmarried couples. The importance of getting legal professional and independent financial advice cannot be underestimated. Taking action is almost always better than doing nothing in this situation.

Between 2002 and 2017, the single-never-married population aged 16 years and above in England and Wales soared by 3.9m, while the number of married people only increased by 1.2m over the same period. Given the rapidly changing demographics, this issue will not go away.