“Where there’s a will, there’s a tax”

The Sunday Times, Money Section, page 13, 4 May 2014-05-05

“Where there’s a will, there’s a tax”

by Mark Canning

Irish families can take some simple measures to avoid the crippling cost of passing on wealth.

IRELAND has the highest death taxes in the world, according to research by accountancy firm UHY.  It found that taxes in Ireland would reduce the value of a $3 million (€2.2 million) inheritance by 26% compared with a global average of 7.7%.

            The report’s authors say low tax-free thresholds mean inheritance tax is becoming an increasing problem for middle-class families.

            

            Thresholds in Ireland have been slashed over recent years.  In 2009 a child could inherent up to €542,544 tax-free from a parent.  Today it is less than half that at €225,000.

            Meanwhile, the rate of capital acquisitions tax (CAT) paid on inheritances and gifts has gone from 20% before November 2008 to 33% today.

            According to financial planning experts there has been a surge in the number of people wanting to know how they can ease the burden.  Eamon Dwyer, managing director of City Life Wealth Advisors in Cork, said: “We have had more inquiries on this issue in the past three months than at any time in the past five years.”

            Oonagh Casey, tax partner with tax adviser Fagan & Partners, said it was becoming a particular problem for Dublin-based clients whose properties had gone up in value.  “People are suddenly getting worried their son or daughter might have to sell the family home to pay the tax,” she said.

So what can you do to beat death taxes?

USE UP THRESHOLDS

Under current thresholds, you can inherit up to €225,000 from a parent, €30,150 from a sibling, grandparent or aunt/uncle, and €15,075 from anyone else without paying tax.

            Using these thresholds efficiently where possible can maximise the amount of your estate that remains tax-free.

            “You should look at the overall picture,” said Casey.  “If your children are married, we would suggest giving some to your child, some to your son- or daughter-in-law and some to your grandchildren with a view to using up their thresholds.”

            Suppose your estate is worth €1 million and you intend dividing it between four married children with each inheriting €250,000. On this basis, each child would have to pay CAT of 33% on €25,000 – the excess over their tax-free threshold of €225,000.

            The inheritance would be tax-free, saving €33,000 in tax, by dividing the estate per family, leaving €225,000 to each of your children, €15,000 to each of their spouses and the remainder to their children.

SMALL GIFT EXEMPTION

Not enough people take advantage of the small gift exemption which allows you to make gifts of up to €3,000 a year tax-free to any individual, say tax advisers.

            Danny Mansergh, principal in Mercer’s financial planning department, said: “The small gift exemption is a powerful tool to pass on wealth tax-free, provided you have the liquid assets to be able to use it.

            “People see the headline figure of €3,000 and think it doesn’t sound like much, but cumulatively it can have a big impact.”    

            Couples, for example, can gift each of their children up to €6,000 a year each tax-free.

            The savings can be significant.  For example, a couple with an estate of €500,000 would trigger an inheritance tax bill of €90,750 at current rates by leaving it to a single child.  If they gifted their child €6,000 a year over 10 years using the small gift exemption there would be an inheritance tax saving of €19,800.

GIFTING ASSETS

According to Alan Murray, tax partner with accountants Mazars, it can make sense to transfer assets that have fallen in value by way of a gift to avoid higher taxes in the future when values recover.

            “Inheritance tax and gift tax is dictated by the value of the assets which you are passing,” he said.  “When property and share values are low you should look at passing those assets on to the next generation to take advantage of those low values.”

            Murray said, in most cases, there would be a double benefit because the person giving the gift would not have to pay capital gains tax if the gift is worth less than what it cost.  Meanwhile, the person receiving the gift stands to benefit from any increase in the value of the asset over the following years.

            For example, if you gift a house worth €200,000 to a child, no tax is due as the value of the property is below the threshold of €225,000.  If the transfer occurs upon your death, by which time the property has risen in value to €400,000, your child would have to pay €57,750 in inheritance tax if their full tax-free threshold is available.

            You can minimise the CAT payable on a gift you intend to make in the future.

            Using a section 73 savings plan, you make regular contributions for at least eight years, after which time you must use the proceeds to pay the CAT on a gift such as property transfer.  The proceeds are not countered as part of the gift and are therefore tax-free.

“It buys you the right in eight years’ time to make a substantial cash gift to your kids or somebody else,” said Dwyer.  “There is no obligation at the end of the eight-year period to make the gift or use the savings to pay gift tax.”

LIFE INSURANCE

If you know your family is going to be hit with a large inheritance tax bill on your death, a section 72 life insurance policy is an efficient way to set aside funds for the tax when it falls due.

            Normally the proceeds from a life insurance policy would form part of the overall estate and become liable for inheritance tax.  With a section 72 policy, however, the proceeds are not counted as part of the estate for tax purposes provided they are used to discharge the inheritance tax bill.

            As with a section 73 policy, you must make regular premium payments for at least eight years to qualify.  “if it’s an illiquid estate that is mostly tied up in one asset like the family home it can make sense for some life insurance to be put in place to avoid it having to be sold,” said Dwyer. Families face tight deadlines for paying inheritance tax so there is not much time to find the money involved.

            Dwyer said it is possible for children to take out insurance on their parents’ lives as long as the parents are willing to go through whatever medical underwriting might be needed.

DWELLING HOUSE RELIEF

In certain circumstances it is possible to inherit a home tax-free using dwelling house relief.

            In order to qualify, the recipient has to have occupied the houseas their main residence for at least three years immediately prior to the date of the inheritance and have no interest in any other property.

            The recipient also has to continue to occupy the house as their main residence for six years following the inheritance.  “It requires the receiver to commit themselves to the dwelling for nine years or more, because you don’t actually know when the giver is going to die,” said Mansergh. “It also requires the giver to be prepared to have the receiver living in their house,” he added.

            Dwelling house relief can also be claimed on gifts.  To qualify, the receiver must prove that, in the three years before the gift, they acted as carer because the giver was infirm or over 65.

‘Minimising the effect of these taxes isn’t hard’

Greg Canty from Cork, who has two children, has started to consider estate planning following a review of his finances by CityLife Wealth Advisors.

            “Everyone has been pushed to the pin of their collar for the past six or seven years, and not been able to put money aside for pensions, life assurance and things like that,” he said. “I’m at the point where I would like to get my finances in order.”

            As part of his financial review, Canty is looking at options to minimise the impact of inheritance taxes.  He intends to use the annual small-gift exemption, which allows gifts of up to €3,000 each year tax-free.

            “I can start putting something aside for my two kids every year, which is exempt from inheritance tax,” he said. 

            Canty is also considering taking out a Section 72 life insurance policy, which could be used by his family to pay an inheritance tax bill.

            “It’s a very simple thing to do and, if the worst happens, at least I know the tax will be taken care of,” he said.  “There are probably a lot of people who would like to leave property for their loved ones and be sure that they won’t end up being forced to sell it to pay the tax.”

            In Canty’s view, current inheritance thresholds are too low, particularly for those with small families.

            “I think the government has gone too far with reducing the thresholds, especially when it’s money that you have already paid tax on,” he said.  “You can’t change the taxation system, but there are things you can do to minimise how taxe has to be paid.”

Mark Channing