Even though it’s common to live together and not get married these days, there is a lot of misconception over financial rights when co-habiting. This article takes a close look at this subject.
Cohabiting couples are the fastest growing household structure in the UK. According to the Office for National Statistics, 61% of the UK population live as a couple and one in five of them are cohabiting and not married*. It’s a common misconception that couples who cohabit have the same legal and financial rights as those in a marriage or civil partnership. This isn’t the case, which can cause major financial issues, particularly if a relationship breaks down or if one partner dies. It’s extremely important that people know and understand exactly what their rights are in order to protect themselves both now and in the future.
There is a widely held assumption that people who live together become ‘common law’ husbands or wives after a certain period of time and are given the same legal rights and securities that married couples or those in civil partnerships have, especially on death or separation. However, in the UK, common law marriages do not exist.
If you are living as a couple and are not married or in a civil partnership, you have less rights, unless you have outlined your wishes in a cohabitation agreement and your Will.
Numerous rights are automatically given to people in legally recognised unions when it comes to tax, death and separation, so it’s important to know exactly what your rights are if you are cohabiting.
There are several tax benefits to being in a legally recognised relationship which are unfortunately not afforded to cohabiting couples. These benefits are certainly not good enough reasons in themselves to get married or enter a civil partnership, but it’s important to be aware of them.
Married couples and civil partners can make inter-spousal transfers of their assets free from Capital Gains Tax. People often transfer large assets, like buy-to-let properties, in this way because of this saving.
This can also result in a significant reduction of Income Tax if one person in the marriage or civil partnership is a higher-rate taxpayer and the other is either a basic-rate taxpayer (in Scotland, a starter, basic or intermediate-rate taxpayer) or a non-taxpayer. If the higher-rate taxpayer owns a buy-to-let property, they would pay Income Tax of 40% on the rental income. If their husband, wife or civil partner is a non-taxpayer, it could make sense for them to transfer the property, as their partner can use their basic personal allowance of £12,570. If the rental income is less than this allowance, it will be free from Income Tax if the property is transferred to the non-taxpayer.
People in a legal union are also entitled to the marriage allowance if one of them is a non-taxpayer and the other is a basic-rate taxpayer (or a starter, basic or intermediate-rate taxpayer in Scotland). This allowance allows them to transfer up to £1,260 of their personal allowance to their partner and results in a tax reduction of £252 per tax year. As the name suggests, it can only be applied for if you are married or in a civil partnership and not if you are just living together as a couple.
Extricating yourself from a relationship is arguably easier if you are not married or in a civil partnership, but if you have spent many years together and built a life, then the separation can be similar to a divorce. But the situation can become extremely difficult when it comes to the division and sharing of assets, as you do not have the same legal or financial rights as those dissolving a legally recognised relationship.
It’s safe to say that not many people like to think about what would happen to them if their relationship broke down, but it’s extremely important to consider this possibility now to avoid problems in the future.
It is common for couples who are cohabiting to live in a house solely owned by one member of the couple. In some cases, people live together like this for many years and both parties end up paying towards the mortgage and running costs of the house despite it only being owned by one of them. If the couple decide to separate, this can be a problem for the person who is not the homeowner as they have no automatic right to the property or to the money that they have contributed towards it, unless stated in a cohabitation agreement.
There are other potential issues if the property is owned by both of you and you split up. Many couples purchase a property as tenants in common (referred to as joint owners in Scotland). Each person owns a share of the property. You can split the ownership equally or one person could own a larger or smaller share, depending on what you decide when you make the purchase. Your share of the property will pass to whoever you leave it to in your Will on your death. Entering into a legal union does not change how the property is owned, but if you divorce, the property can be considered part of the matrimonial assets. These are all of the assets which have been accrued by both parties during the period of the marriage or civil partnership, so how the property is split will be negotiated and decided with legal backing. If you are cohabiting, you do not have the same legal rights on separation. Unless you both agree on what will happen to the property and how the value will be split, you could end up in a situation where you have to continue living together until a compromise is reached.
If you are cohabiting and split up, you are not automatically entitled to anything from your former partner’s pension, unless you previously outlined this provision in a cohabitation agreement.
On the other hand, in a marriage or civil partnership, if a pension has been accrued during the time of the union, it will form a part of the matrimonial assets. If the relationship ends in divorce and one person has built up a substantial pension pot, the other member of the couple has an entitlement to it. This is known as a pension sharing order.
On divorce, any savings and investments (including those held within ISAs and general investment accounts) will be classed as matrimonial assets and could be subject to splitting, even if they are held individually. In Scotland, it is only those which have been made during the course of the marriage or civil partnership.
If you are cohabiting and then separate, unless outlined in a cohabitation agreement, any savings and investments held in individual names will be retained by the original owner. Unless the investments were held in a joint general investment account, the other party may have no claim to their former partner’s assets.
Sometimes, throughout the course of a relationship, one person receives an inheritance. If it is substantial, it is often used towards paying off a joint mortgage. If you later separate, it can be difficult to protect this payment if you are cohabiting. You may not have the same power to negotiate as you do not have the same level of relevant laws and rights on your side like those people in a legally recognised union. They can use what is known as a ‘source of funds’ argument to ring-fence the payment so that it is not subject to splitting.
People who divorce may be entitled to spousal maintenance (or spousal aliment in Scotland). These payments are awarded through the court and can be paid for a temporary period or for life. If you were previously cohabiting and then separate, you are not automatically entitled to any such support from your former partner.
If there are children involved, anyone who has parental responsibility for the child is responsible for paying towards their upbringing, regardless of whether or not they are married or cohabiting. Usually, parental responsibility is granted to the people named on the child’s birth certificate (depending on when the child was born). Ongoing maintenance is usually payable by the parent who the children do not live with for the majority of the time.
The death of a partner is often one of the most emotionally difficult periods in anyone’s life. Finances and tax are often the last thing people want to deal with when they are grieving, so it’s important to know what your future position could be now when you are likely to have greater mental clarity. It’s also vital that you have the correct paperwork in place, or you could leave yourself or your partner extremely exposed and financially vulnerable.
Having an up to date Will is essential to effective estate planning, especially if you are cohabiting. Without this, the law decides how your assets are divided and your partner is not automatically entitled to anything. Instead, they will be passed to your next of kin. If you have children, your estate will usually go directly to them and if you don’t, it could go to your parents or siblings. This can be especially problematic if your home is owned as tenants in common or if it is solely owned by the person who has died. Your partner may be forced to move out or to sell the property in order to pay your next of kin their inheritance. For example, your property could be passed to a sibling who you have not spoken to for 20 years instead of to your unmarried partner of 25 years, because you did not have a Will in place.
Inheritance Tax is not payable between married couples or civil partners. It is, however, payable if you leave assets to your partner and you are not in a legal union. If you have assets valued at over the nil rate band (including your main residence), Inheritance Tax will become chargeable.
Both the nil rate band and the residence nil rate band can be transferred between married couples and civil partners when they die. This can result in a substantial saving for any children after the second death. These bands cannot be transferred between unmarried couples, which could have a detrimental impact on the amount of money that their children receive. If you’re not married, you only have your own nil rate band (£325,000) and residence nil rate band (£175,000). With property values continuing to rise, the combined value of these bands (£500,000) may not even cover the value of your home, let alone any other assets.
The rules around what happens to a pension on your death differ depending on what type of plan you have:
On death, a defined contribution pension can be passed on to anyone that you choose and not necessarily a husband, wife or civil partner, as long as you have nominated them as a beneficiary with your pension provider. Defined contribution schemes are the most common type of workplace pension, but unfortunately, many people are unaware of the importance of completing the nomination of beneficiary paperwork and keeping this information up to date. It is, however, often a very simple, quick and easy matter to sort out directly with your pension provider which could save you and your partner from a financial nightmare in the future.
Defined benefit pension schemes, or as they are usually known, final salary schemes, are far less common than they used to be but there are still a number of people who are members of this type of pension. You can only leave a defined benefit pension scheme on death to a husband, wife, civil partner or dependent child under the age of 23. It cannot be passed to your partner if you are not married. This is not necessarily a good enough reason to move out of a defined benefit scheme (or to get married!) but it’s something you need to be aware of.
Pensions are a great estate planning tool. As they automatically fall outside of your estate, no Inheritance Tax is payable on them and if you die before the age of 75, they will also be passed on free of Income Tax.
The first step to securing your financial future while cohabiting is to talk to your partner. Sadly, many people feel uncomfortable discussing financial matters with their partner and bury their head in the sand. As discussed here, this can have huge ramifications if you separate or one of you dies.
For many cohabiting couples, the best way to protect their assets is to establish a cohabitation agreement when they decide to move in together. A cohabitation agreement can also be established even if you have been living together for a long time. You can add anything you like into the agreement (as long as you both agree to it) and this can help to make sure that you are treated fairly in the event of separation or death. If you decide to get married in the future, the cohabitation agreement can quite easily be turned into a prenuptial agreement.
We have a lot of experience of working with cohabiting couples, as well as those who are married or in a civil partnership, and help them to secure their finances both now and in the future. If you would like to know more about how they could help you, contact us now. Book a no-obligation, free initial consultation online or call 020 7189 2400.
Issued by Tilney Financial Planning Limited.
* Source: ONS, 2019