(MONEY Magazine) – WHEN SANDRA DAWSON, 32, DISCOVERED SHE WAS pregnant last October, her boyfriend, Alan Gugel, 30, was thrilled. "We'd been talking about having a baby for a couple of years, and we'd just started trying," reports Gugel, a quiet, good-natured chap with a ready smile.

To the Chicago twosome, the child's arrival, anticipated in early June, demonstrates the strength of their commitment. In the six years they've lived together, Dawson, a painter and art teacher, and Gugel, an artist and furniture designer, have successfully weathered trials that split up many other couples. For instance, they have survived the inevitable periods of penury and stress that accompany the determination to launch two art careers. Their combined annual income, as low as $12,000 in 1990, has recently risen to $59,140. Dawson, a no-nonsense redhead, stood by Gugel during his three-year struggle with alcoholism. "In 1992 I told him, 'I'm leaving you if you don't get into treatment,'" she recalls. He's been sober since that year.

But get married? Hey, no rush. Like the nation's 3.5 million other cohabiting couples of opposite sexes, up from 2 million in 1985, Gugel and Dawson say they simply prefer to live together unhitched, for now. Half of all adult Americans under the age of 40 have lived with a mate outside of marriage, according to a comprehensive longitudinal study by the University of Wisconsin. Though many singles see living together as a chance to test a relationship for permanence, it doesn't improve the odds of staying together as man and wife. Fully 36% of first marriages between people who have lived together end in separation or divorce within 10 years, vs. 27% of first marriages for others who have not. Cohabitation does, however, let couples save money on housing and thumb their noses at hidebound notions of a traditional union. "Marriage should be a relationship, not a contract," Dawson insists. "And Alan and I don't care about a contract."

Maybe they should. Creating a family without a legally sanctioned union can be a tricky thicket indeed. Dawson and Gugel are largely -- and dangerously -- in the dark about the financial and legal ramifications of their living arrangement. True, they skirt the so-called marriage penalty -- a tax code quirk that causes married joint filers to pay more than unmarried couples with equal incomes. And they avoid an expensive divorce if the relationship ends. But they lose some rights that marrieds take for granted. An unmarried partner can't automatically make medical decisions for the other, automatically inherit from the other or even, as a rule, piggyback the other onto a low-cost insurance policy. If they remain unmarried, they wonder, what legal and financial steps should they take to protect themselves and their baby?

A native of rural McLaughlin, S.D., Gugel admits that personal experience made him leery of marriage. At 20, he wed a fellow art student. "By the first year, I realized we'd made a terrible mistake," says Gugel. "I never want to go through that again." A few months after his divorce was final in February 1989, he met Dawson when she walked into the Chicago coffeehouse he was managing part time. By winter, he had left his $250-a-month apartment to move into her larger $500-a-month place.

"I was thinking, 'Living together would be fun. Let's do it,'" Dawson says frankly. "I wasn't thinking about marriage." The institution had left its mark on her too. Her parents separated in 1982 when she was an impressionable 19, leaving her shocked and upset. "I believe in love, commitment and two people being able to last forever," she says, "but I've seen a harsher reality."

Convinced that their toughest times both as a couple and as struggling artists are behind them, the pair are now focusing on building their finances and making a life. In April 1994, they felt confident enough about their financial situation to move into a 5,500-square-foot loft in an industrial area near Chicago's arty River North district (monthly rent: $916, including heat and electricity). They put both of their names on a five-year lease, giving them equal claim to the apartment.

Then there's the matter of paying that rent. Most of Gugel's pieces, line drawings attached to constructions of wood, metal and concrete that the Chicago Tribune calls "curious meldings of art and engineering," retail for $1,000 to $5,000. But Gallery A, which has shown his work since 1992, takes a 50% commission -- standard in the art business. Over the past 12 months, Gugel earned only about $21,000 from his art. But at least that's up from the $12,000 he made in 1993.

The pragmatic Dawson was the one who took a regular job in 1992 to ensure the couple a steady income. This past school year, she earned $25,000 as an art teacher in the Chicago public school system working with disabled youngsters. The trade-off: Her art career has languished, and her paintings, which rely heavily on images of angels, swing sets, hopscotch and other childhood symbols, earned her about $4,000 last year. "We're always broke," she says.

Like most couples who live together, Dawson and Gugel try to keep their finances separate. They maintain individual checking accounts, and they each cover certain agreed-upon expenses: Dawson usually pays their rent while Gugel meets other household bills, including the roughly $70-a-month telephone tab and the $78-a-month insurance on their two vehicles. They split their $300-a-month grocery tab equally. In practice, though, they wind up pooling income. "If Alan is short on money, I'll cover him, and vice versa," says Dawson.

Low income plus high expenses means low savings. In addition to the $320 she put toward her school-system retirement plan last year, Dawson was able to add just $200 to her Individual Retirement Account, now worth $1,600. The account is invested in Smith Barney Appreciation (12-month return to May 1: 13.2%; 800-451-2010), a growth-stock fund. In 1985, Gugel inherited 40 acres of South Dakota farmland, currently valued at $5,000, from his late grandmother. Their only liquid asset is a savings account at Chicago's First Bank (current balance: $8,500; interest rate: 3%). Held in Dawson's name because she contributed most of the money, it's earmarked for a down payment on the home they hope to buy in the city within four years. Gugel is also saddled with a $15,000 student loan and $2,000 worth of credit-card debt, racked up mostly by taking out cash advances during post-divorce hard times.

Their families aren't hassling them about getting married. Nor has Dawson's pregnancy caused her problems at work -- though the immediate response of a few fellow teachers was, she says, "You'll be getting married now, right?" Sometimes the couple find it easier to fib. "At art openings and things like that, I always refer to Sandy as my wife," says Gugel. "If I say, 'My girlfriend's pregnant,' people say, 'Wow, bummer.' But when I say 'My wife's pregnant,' they say 'Hey, that's great!'"

Dawson plans to give up her job after the baby is born, even though it means she'll lose her salary plus generous employer-provided health coverage through an HMO. Gugel, ever the optimist, is in full agreement, saying firmly: "I owe it to Sandy for her not to have to teach after the baby comes." But how will they cover living expenses? A recent U.S. Department of Agriculture study shows that a first baby typically costs its parents $8,660 in its first year. "If we need more money, I'll make more money," says Gugel confidently.

Thanks to skills he learned from his late father, a contractor, Gugel can do part-time plumbing and building work. He's also trying to develop fledgling side businesses, such as designing unusual tables that resemble his sculptures, which brought him about $8,000 over the past 12 months. Dawson says she might also work a few days a week as a substitute teacher. This strategy, they think, will still allow Gugel to tend the infant every morning while Dawson paints. In the afternoon, he'll work while she minds the baby.

They may seem cavalier, but compared with the artistic community in which the couple move, they are downright conservative. For instance, they paid an accountant $1,700 over the past 12 months, in part to help maximize their complicated art-related tax deductions. And Gugel is one of a very few artists to have purchased health insurance. He bought a $220 six-month catastrophic policy through insurer John Alden last October after he accidentally cut off the top of his left ring finger with a belt sander (medical bills totaled $1,200). Dawson was careful to check with her employer to make sure that the baby's birth will be covered before her health coverage lapses once she quits her job. They realize they'll need health insurance for the baby. Occasionally they fret about the possible complications of giving birth too. "If anything happens to me during labor, I want Alan to have custody of the child," says Dawson. They'd also like their estates to pass to each other. But neither has a will.

Weighty concerns like these, as well as growing confidence in the permanence of their already durable union, have the couple thinking that they'll probably get married after all. According to sociologist Larry Bumpass, who conducted the University of Wisconsin study, 60% of cohabiting singles do wed eventually. Ironically, Dawson and Gugel feel one of their biggest obstacles to tying the knot is money. Says she: "We see getting married as a celebration of our union, and we'd want to do it right." Doing it right means a festive $3,000 to $4,000 reception-but that's money that they feel they can't spare now that they have a baby on the way.

THE ADVICE

AT MONEY'S REQUEST, ANITA BOLANOS, a family law attorney with the Chicago firm of Schiller DuCanto & Fleck, and Gary Bowyer, a certified financial planner in the city, met with Dawson and Gugel last spring to advise them on their best moves. The bottom line: "If they want to make a life together, the legal system makes it easier for them to be married," says Bolanos.

But if Dawson and Gugel are not certain that they want to be together permanently, they should remain unmarried, both advisers say. Unmarried couples can uncouple more easily, so long as they've been careful to be specific about who owns what. They can then make their own monetary, child-custody and visitation arrangements without a court's interfering.

The purely monetary considerations of living together vs. marrying are a wash. Bowyer points out that since both plan to be self-employed, neither will have employer-provided health insurance that would enable one of them to extend coverage to spouse and child at low cost. And today, marrieds buying their own health coverage typically pay the same rate as singles. The unlimited tax-free transfer of assets that the law allows between spouses doesn't matter to these two because their net worths are less than the $600,000 that anyone can leave tax-free. On the other hand, the income tax penalty of marriage wouldn't affect them much either. The typical couple earning $30,000 apiece would pay $3,300 more in federal taxes by marrying. But high art-related deductions, enabling Dawson to pay only $1,046 in federal taxes last year and Gugel nothing, mean they wouldn't pay much more if they wed.

If they do decide to remain unmarried for now, the advisers say they should:

-- SEE AN ESTATE-PLANNING ATTORNEY. Before the child is born, they should sign the following: wills to leave each other property and name each other the child's primary custodian and legal guardian if one of them dies; living wills to set out their wishes about measures to prolong their lives; durable powers of attorney for health care in which they establish the right to make medical decisions for each other; and durable powers of attorney for financial management to name each other to handle the finances should one become mentally incapacitated. Bowyer estimates that these documents will cost them $1,000.

-- ESTABLISH GUGEL AS THE BABY'S FATHER. He should write his name on the birth certificate when the child is born. He and Dawson should also sign a notarized parenthood statement acknowledging that he's the father. These measures protect Gugel's right to see the child and Dawson's right to have him help support the child if they separate.

-- BE SURE TO ATTACH THEIR NAMES TO ASSETS THEY OWN. Living-together contracts that spell out who owns what and how it will be divided if the relationship ends are unenforceable in Illinois. Therefore, Bolanos says, "They have to title their property carefully so that everybody knows what's going to happen if they split." For example, Gugel has no legal claim to the couple's savings account, because only Dawson's name appears on it. But rather than add his name to hers, he should open his own account. That way they each control their own money and keep it safe from the other's creditors.

Should they buy a home together, they must be sure to include both of their names on the deed as joint tenants with right of survivorship. Then if one of them dies, the other automatically inherits the house. But if they have any doubts that they'll be together for the long haul, they might list themselves as tenants in common. Should one die, the survivor gets his or her share of the property and the deceased's beneficiary gets the rest.

Whether they marry or not, the couple must:

-- SET SPENDING AND SAVING PRIORITIES. "I'm concerned that they're going to have a three-person family at the same time they have a drop-off in income," says Bowyer. Therefore, they should rigorously clamp down on nonessential spending for gifts, donations, restaurant meals and entertainment, while they try to increase their income by building Gugel's furniture-design business. Bowyer also suggests that they move Dawson's $8,500 savings out of the 3% bank account and into a money-market fund such as Vanguard Prime Portfolio (recent yield: 5.9%; 800-851-4999). They should keep that money liquid as an emergency fund and add to it for the down payment on their future home.

-- SHOP HARD FOR AFFORDABLE HEALTH INSURANCE. Under the so-called COBRA law, Dawson can extend her employer-provided medical coverage at her expense for 18 months after she quits. "But she should shop for another policy now," says Bowyer. He recommends Des Moines-based Principal Mutual (800-986-3343), which would charge Dawson $222 a month for a standard policy with a $1,000 deductible. Gugel would pay a reasonable $156 a month for similar coverage. Piggybacking the baby on one of the Principal policies would add about $88 a month.

-- BUY TERM LIFE INSURANCE. Coverage of $250,000 each, at a cost of about $500 total, would help provide for the child should they die.

"I feel like we should get married tomorrow!" an overwhelmed Dawson said at the close of the session with the advisers. But a few weeks later, after Gugel purchased the recommended health insurance and she elected to continue her current coverage under COBRA, they felt less urgency. "We've decided to stick to our original plan and get married in a year," she reported in May. They are putting off estate planning until they marry, in part because of the expense. "Some people might not understand that decision," Dawson says. "But we live a little differently from most people."