On The Money: Nothing is more certain than death and inheritance tax
In recent years one of the most frequently raised financial planning issues has been inheritance tax planning.
As property prices rise, investments increase in value, all of this of course is good news however on the other hand it also creates the inevitable problem of inheritance tax for many people.
Inheritance tax also known as Capital Acquisitions Tax (CAT) was traditionally seen as a problem only for the very wealthy, however this is no longer the case.
Successive budgets since the financial crisis slashed the tax-free inheritance thresholds for passing assets from a parent to a child - the Group A threshold was as high as €542,544 in 2009, cut all the way down to €225,000 in 2012, thankfully this trend has been reversed in recent budgets and the level is currently €335,000.
To make matters worse, during the same period the tax rate which applies to Inheritance and gifts was increased from a low of 20% in 2007 to the current level of 33%.
While an inheritance threshold of €335,000 from parent to child may seem quite generous (and it is in most cases), it creates significant problems for those who inherit illiquid assets such as property from their parents.
Let’s take an example of a couple in their mid 50s with two children in their 20s, their assets consist of the family home, a small family business, cash deposits, an investment property and a company pension.
Let’s assume the total value of their assets is approx. €900,000. In the event of both parents dying and the two children are the sole beneficiaries, they would each receive €335,000 tax free but the remaining €230k in the estate is liable for Inheritance tax at 33%, leaving a total tax bill of €75,900 or €37,950 each. If the children inherit ‘liquid’ assets such as cash deposits then these can be used to pay the tax bill, however if the inheritance consists of ‘illiquid’ assets such as property this can cause major problems. We all know from recent experience that property is far from a liquid asset, and may not be easily sold in the short term.
There are a number of ways this potential problem can be addressed in advance with some long term financial planning.
Section 72 life assurance policy
The first solution in this example would have been to put in place a Section 72 life assurance policy. This is a specific type of policy which pays out on the second death of the parents, the level of life cover in place should be equal to the estimated inheritance tax liability, €75,900 in this case. Section 72 of Capital Acquisitions Tax Consolidation Act 2003 states that the proceeds of this type of policy are exempt from tax, as long as those proceeds are used to pay the inheritance tax that arises on death.
Another way to avoid a potentially large inheritance tax bill is by drip feeding the Inheritance by utilising the annual small gift exemption.
Tax legislation allows for an annual exemption for the first €3,000 of any gift taken by a beneficiary from any one donor. This means that a beneficiary can receive up to €3,000 tax free in any one year from any donor, or even multiple donors.
One practical application of this is where parents, grandparents, aunts and uncles gift money to children. Each adult can gift each child up to €3,000 in any year with no tax liability for the child and without reducing the amount the child can ultimately inherit tax free.
For example, if each parent gifted €3,000 pa to each child in the earlier example, this would enable them to gift €120,000 over a 10 year period completely tax free, thus eliminating the inheritance tax bill altogether. Most importantly, this €12,000 would not impact each child’s tax free inheritance threshold of €310,000.
It should be remembered that Gift Tax is a self-assessment tax. The obligation to make a return to the Revenue Commissioners rests with the person who receives the gift.
An Inheritance Tax/Gift Tax Return must be filed when a gift either by itself or when aggregated with prior gifts exceeds 80% of the appropriate tax-free threshold amount. This reporting rule does not apply to the annual small gift exemption.
Another important point to note is how the rules differ between Ireland and the UK. In Ireland inheritance tax is paid by the beneficiary, unlike the UK, beneficiaries do not normally pay inheritance tax on things they inherit as this has all being dealt with by the Executor or the person in charge of dealing with the Estate prior to a beneficiary receiving the asset.
For those who believe they may have a future inheritance tax liability I would advise you to speak to an independent adviser and put a plan in place. If you are considering a Section 72 policy, I would advise you to put it in place well before the maximum age of entry which is normally at age 75.
Anyone who owns a property and/or an asset such as a savings plan or deposit account should make a Will. Not only does a Will ensure that you distribute your wealth/assets as you wish but it also means that your family and beneficiaries are spared the expense and distress of a complicated and drawn-out administration of your estate.
Barbara McManus QFA is a Financial Advisor with Wealthwise Financial Planning, Hartley Business Park, Carrick on Shannon, www.wealthwise.ie. Wealthwise Financial Ltd T/A Wealthwise Financial Planning is Regulated by the central Bank of Ireland. All details and views contained within this article are for informational purposes only and does not constitute advice. Wealthwise Financial Planning makes no representations as to the accuracy, completeness or suitability of any information and will not be liable for any errors, omissions or any losses arising from its use.
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