Co-habiting couples and their rights

What is cohabitation?

Cohabiting is living together as a couple just like a married couple but unlike marriage/civil partnership which is 'the legal and formal recognised union of two people' it is not recognised in law.

Whilst some cohabiting couples refer to their partner as their 'common-in-law spouse', in law cohabiting couples are not granted the same rights as married couples.

Intestacy

It doesn't matter how long a couple has lived together and whether they think that they are in a 'common law marriage', the law is clear. Unless married or in a civil partnership, there are no rights under the law of intestacy to assets which were owned by the person who died.

The law varies between the three legal jurisdictions in the UK but is similar when there isn't a will; close family such as children will be first in line, and potentially a separated spouse could benefit. If there are no children, then parents and siblings are next. And so, it goes on.

The surviving cohabitee could apply for reasonable financial provision if they can demonstrate that they were living effectively as husband/wife/civil partner for the two years preceding death or if they can show they were being maintained by the deceased immediately prior to death. But there is no guarantee that they will get anything.

Therefore, it is important that cohabiting couples have up to date wills.

Inheritance tax

We often hear about the magic £1 million of assets which are inheritance tax-free. But of course, that's due to a combination of the spousal exemption and transferable nil rate bands and these don't apply if someone is a cohabitee.

If you've lived with someone for 50 years and die with £800,000 of assets which you leave to your partner, £325,000 will be inheritance tax-free, with the remaining £475,000 taxed at 40%. This can mean family homes need to be sold to pay inheritance tax bills - a stark, but realistic example. No inheritance tax would be due if the couple were married.

Capital Gains Tax

As a reminder, capital gains tax (CGT) is charged on the profit made when selling or disposing of shares, funds, business assets and personal possessions worth more than £3,000, or on a property that's not the main family home which has increased in value. It's the gain that is taxed and not the total amount of money received.

Taxable gains are charged at 18% and 24%, depending on your income band. If someone has capital gains that exceed their annual exempt amount, then this sits on top of the individual's taxable income to work out what rate of tax is due. The annual exempt amount is currently £3,000.

If married, you can transfer or gift an asset to your spouse or civil partner without becoming liable for CGT. This can have valuable advantages, for example, the ability to spread assets to use both annual exemptions and/or use any available basic rate tax band. The gain or loss will be calculated from the date the asset was first owned, and not the date the spouse received it.

However, the same rules don't apply if you cohabit with someone. You are treated as separate individuals and if you gift something to your partner then CGT may be payable. When you inherit an asset through death, inheritance tax is usually paid by the estate of the person who's died. If you later dispose of the inherited asset, you will then need to work out if CGT is also due. This could mean that you receive property on the death of your cohabitee, you'd potentially pay inheritance tax in the first instance and then, years later, if the property is sold at a substantial profit, be liable for a further tax bill.

Pensions

For those clients in defined contribution schemes set up under discretion, scheme administrators will look at the expression of wish form and look at other evidence such as financial dependency which would normally mean the correct people should receive the death benefits.

However, consider the situation where there is a separated spouse and no divorce has ever been obtained, or if there are children under 23. If there is no expression of wish form in place and the cohabitee doesn't fit the legal definition of a dependent, then, while the scheme administrator could still choose to give the money to the cohabitee, they would be limited to only giving a lump sum as there is a dependant still alive.

If the person who dies is 75 or over, this could mean paying a large amount of income tax, whereas if the partner had been able to move into beneficiary's drawdown, they might have been able to take it out tax efficiently.

If you have clients in the public sector though, they might sometimes presume that, due to the changes in law, cohabitees will have the same rights as those who are married. But it's not quite as easy as that. The right to a survivor pension for cohabitees was only introduced as part of earlier reforms in the mid-2000s but this change wasn't applied retrospectively. It's important to check what the scheme rules say in relation to cohabitees.

Common to all schemes was the requirement for the cohabitees to meet eligibility criteria designed to ensure that the relationship was a truly committed one. Meet someone and marry them within a few months and there is no need to prove that you're in a committed relationship. But if you have cohabited for less than two years then you won't be entitled to anything.

Individual Savings Account (ISA)

Many people save into ISAs and, by using their full individual allowances every year, couples can build up a substantial portfolio of investments over time, which can provide them with income and growth in the future. Although taxed on the way in, the key benefit of an ISA is they are tax-free on the way out.

However, cohabiting couples should be aware of the inheritance tax implications of ISAs. Unlike married couples or civil partners, who can inherit a deceased spouse’s ISA allowance through the Additional Permitted Subscription, cohabiting couples can't do this. If one partner dies, their ISA loses their tax-free wrapper, and the surviving partner may have to pay inheritance tax on the value.

Marriage allowance

If a person is married or in a civil partnership, currently earning less than the personal allowance of £12,570, and their spouse or civil partner pays income tax below the higher rate, then £1,260 of their allowance can be transferred to the spouse or civil partner. Although this might not seem like much, it is a saving of up to £252 a year that is not available to cohabitees and it may be especially valuable in retirement when many couples are basic and non-taxpayers.

Conclusion

Although many people just don’t want to get married, understanding the differences can help navigate the planning opportunities for cohabitees. Ensuring they have up-to-date wills and expression of wish forms and perhaps a trust in place, would make things much more straightforward for you and your clients. But there will always be circumstances where they will be financial disadvantaged no matter what they do.