02 Sep Avoiding Inheritance Tax for Cohabiting Couples in Ireland

Many couples are taking the cohabiting route, choosing to postpone marriage or to not enter it at all.  Did you know that in the eyes of the law, you are treated as strangers if you leave each other assets on death, and will attract significant tax implications?

Who qualifies as a Cohabitant under Irish Law?

Two adults who have lived together for two years where there are children in the relationship, and five years where there are no children involved. Previously, non-traditional families had no legal status and so did not have the same legal rights as married couples and civil partnerships.

The Civil Partnership and Certain Rights and Obligations of Cohabitants Act 2010 was a milestone for cohabiting couples. This Act provides cohabitants with extensive information on further entitlements, such as maintenance, property, and inheritance rights. However, cohabitants still need to consider the important implications that arise on death of a partner (succession), and Tax liability.

Implications on death of a partner

Married couples or those in a Civil Partnership are governed by the Succession Act allowing the surviving spouse a legal right to a share in each other’s estate. If you are in a Cohabiting relationship, without a valid will you would have no automatic right to any share in assets or the estate of your partner on their passing.

Inheritance & Gift Tax (Formally Known as Capital Acquisition Tax or CAT)

In the case where a married or civil partner inherits or receives a gift from their partner, there would be no tax considered. However, cohabiting couples would have to pay tax as they would be seen as ‘strangers’ in the eyes of Revenue.

On receiving a gift or inheritance surviving partners are provided with the Inheritance Tax threshold of up to €16,250, however, generally given size of the gift or inheritance value such as property, this could result in an particularly unfortunate Tax bill, as anything in excess of this threshold would be taxable at a rate of 33%.

One small loophole is the Principal Dwelling Exemption if you can prove you have lived in the same property for 3 years prior the inheritance and you have no other beneficial interest in any other residential property at the date of the inheritance, and you stay in the property for a further 6 years after the inheritance. You can find more information here: Rights of cohabiting couples (couples living together) (citizensinformation.ie)

Another loophole is the small gift exemption.  Anyone can receive €3,000 per year from anyone else without any tax implications.  This small exemption does not apply to inheritances on death.

Protecting against Inheritance Tax

For cohabitants, setting up Life Assurance correctly with the advice of a Financial Broker is the smartest way to reduce inheritance tax. Many cohabiting couples that have  Mortgage Protection in place may not fully understand how Revenue will treat the inheritance of the property of the surviving partner. If structured correctly, taking out a life insurance policy on a ‘Life of Another basis’ will help to remove any unexpected tax concerns. There are various conditions that must be in place such as who paid the premiums on the policy, who owned the property, and how the policy was set up.

This process is done by taking individual policies on each other’s lives, paying the premiums on the cost of the insurance for the other party, running for the same length of time as the mortgage.

Let’s look at the below example that illustrates a cohabiting couple:
 

Robert and Jack live together and buy a house in their joint names valued at €500,000. Each contributed to paying for the deposit of €50,000.  They take out a joint Mortgage Protection Policy for €450,000 to pay off the mortgage, should one of them pass away. Both Robert and Jack are working and the mortgage protection premiums are paid from a joint bank account. In the first year Jack dies and the mortgage protection policy pays the bank to clear the mortgage.

• Robert already owns 50% of the property, so he will inherit Jack’s half of the property.
  • 50% of €500,000 = €250,000
• Robert must therefore pay 33% of any inheritance over the threshold of €16,250.
  • 33% X (€250,000 – €16,250) = €77,138 as Robert’s Tax Liability

Even though the mortgage protection policy cleared the mortgage, because Robert has technically inherited Jack’s half of the property he is now left with an unfortunate tax bill.

In a time of tragedy, no one should have to consider how they are going to afford a tax bill.

How does Life of Another solve this problem?

1. Two Single Life Policies – Both earning an Income

Each partner sets up their own Single Life Mortgage Protection Policy, insuring each other’s life for the full mortgage amount of €450,000 (purchase price of the property less the deposit). This would be referred to as a “Life of Another” policy.

For the policy to be structured correctly, each must ensure the premiums paid on each policy comes from their own bank accounts funded by their own earnings, and not a joint account.  Referring to the example above, should Jack’s premature death occur in the first year, the benefit paid out would belong to Robert as he is the owner of the policy on his life and paid the premiums, ensuring  Robert’s inheritance would be reduced in the event of Jack’s death (and visa versa).

Robert would thereafter inherit the mortgaged portion of the house and be exempt from paying for Inheritance tax on that portion. However, he would still have to pay for the mortgage-free value that he inherits.

Mortgage free value would be the €50,000 deposit paid, and any increase in the value in the property since purchase.  Let’s assume the property has not increased in value, €25,000 of the deposit came from Robert, so he is assessed for tax on €25,000 that Jack paid.  Sarah will have to pay 33% Inheritance tax on the amount inherited over €16,250:  33% (€25,000 – €16,250) = €2,888

Arranging your mortgage protection cover on ‘Life of Another’ basis and paying from your own personal accounts makes sure that potential tax liability will be significantly reduced.

 Other ways to Reduce Inheritance Tax Liability

You can take out a larger amount of cover, so there are fund remaining after the mortgage is cleared to pay the inheritance bill.   This option is quite suitable where there is only one earner in the house hold and premiums must be paid from their account.  Or when one person owns the property/assets and subsequently has a partner.

You can take out a Section 72 Life Assurance policy

A Revenue approved whole of life product designed specifically to deal with inheritance tax. For example, when parents or grandparents want to leave assets to their children that will be well in excess of the gift and inheritance tax thresholds. When parents bequeath a property to their children. It works similarly to regular Life insurance where you would pay the premium on your policy, and on death your beneficiaries would receive a tax-free Lumpsum to cover the tax bill. Revenue do not charge Capital Acquisitions Tax (CAT) on the proceeds if the money is paid out from the Section 72 policy.  If there is excess cover after the inheritance tax is paid, then CAT would apply to the excess.

In Summary

There are many strategies to reduce potential inheritance and gift taxes, with may options when it comes to life assurance.  It is importance to seek advice from a Qualified Financial Advisor who will assess your current circumstances and help put together suitable solution tailored to your specific needs.

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