Inheritance tax issues for cohabiting couples

Are you one of the 150,000 cohabiting households in Ireland? Are you aware of the potential inheritance tax consequences of misconfigured life insurance?

Recently, when reviewing the life cover of clients who were an unmarried couple with young children, we discovered that their protection policy was poorly structured and would have resulted in an inheritance tax bill if either they were to die.

The Civil Partnership Act 2010 granted same-sex couples the legal status of “civil partnership”, meaning they now had the same property and financial rights as married couples. Unfortunately, the law has done little for opposite-sex cohabiting couples, this cohort is approx. 15% of all Irish households according to recent census data.

These cohabitants can now legally claim the estate of their deceased cohabitant. However, many of them are unaware that inheritance tax still applies and in the eyes of the taxman they will be classed as “foreigners”, meaning they will only have a lifetime inheritance threshold from the group C of €16,250.

If you are part of a cohabiting couple, there are a number of important points you should be aware of when taking out a life insurance policy. If you take out a life insurance policy on your own life, your surviving partner may end up with inheritance liability. If the survivor is deemed not to have paid premiums, problems arise!

Let’s take a practical example of a cohabiting couple, John & Mary, they decide to take out a life insurance of 200,000 € in common life to cover the losses that each could suffer if one of them were to die. John is currently unemployed, so Mary is paying the full policy premium until John is rehired.

What would be the situation with regard to inheritance rights if Marie were to die? Unfortunately for John, as Mary paid all the premiums, he is deemed to inherit all of Mary’s €200,000 and must pay inheritance tax. Assuming he has not received any other assets under the Group C threshold before, his tax liability is: €200,000 – €16,250 x 33% = €60,637,

If John could prove that he paid half of the premiums into their joint account, it would help cut the tax liability in half, as it would be assumed that he inherited half of the sum insured. €100,000 – €16,250 x 33% = €30,318. Either way, John finds himself with a large bill to pay by a certain deadline.

So what is the best solution for a cohabiting couple?

1. Solution “The life of another”
A more appropriate structure would be for John & Mary in our example to take out 2 separate life insurance policies as part of a “substitute life” agreement. This means that each of the policies is held separately, clearly identifiable and there should be no future estate tax to pay as each pays for its own policies. If, as in our example, John is unemployed and unable to pay the premium, this problem can be solved by Mary using the annual tax exemption on small donations by “giving” the premiums to John. This small gift tax exemption allows €3,000 per year to pass from one person to another, so if the premiums are less than €3,000 per year, John can claim that the premiums were gifts. Therefore, in this new scenario where Mary was to die, John receives the proceeds of the policy he owns without any obligation to pay inheritance tax.

2. The “section 72” solution
Alternatively, each of them could take out a separate life insurance policy under Section 72 to reimburse any inheritance tax, these policies are exempt from inheritance tax to the extent that the proceeds are used to pay the inheritance rights. This arrangement may be more important to cover any tax liability for the dwelling house in which the couple lives. For John & Mary, if they buy a house in common and one of them dies, the survivor may be liable for inheritance tax on the value of the house (assuming the house is jointly owned) .
However, in this case, they can benefit from the exemption for dwelling houses. The Dwelling House Exemption provides full relief from inheritance tax on the value of their home, under certain conditions. It is not uncommon for cohabiting couples not to meet the necessary criteria and therefore be faced with a tax bill.

In conclusion, life cover for cohabiting couples is a complicated area, it can be very expensive if you choose the wrong type of cover, always seek the advice of an independent professional.

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