Martin O’Sullivan: Insuring against a tax shock on inheritance
In my early years of practice, when the capital tax relief was not as generous as it is today, I frequently encountered instances where substantial obligations vis-Ã -vis capital acquisition tax (CAT) occurred.
Some of our more experienced readers will remember the days of âinheritance taxâ, which decimated many family farms.
Fortunately, these days, gift or inheritance tax can be avoided with good planning in the vast majority of cases. – but not in all cases.
Land prices go up to the dizzying heights of the boom years; which, coupled with growth in savings and investments, in particular Coop and Plc shares, has put CAT back into play.
It is usually nonfarm assets that contribute to the problem – not only are they subject to tax, but they also create a situation where people may be denied essential relief such as Agricultural Relief, which under certain conditions will reduce the assessed value of farm assets by 90pc.
Good planning can be invaluable. I encounter far too many situations where it is too late to do anything about impending liability, usually because the custodian has passed away.
Often, a particular instruction in a will could have provided the beneficiary with an escape route that could have saved thousands of dollars or even hundreds of thousands.
In other cases, the custodian may have had the foresight to take out insurance that could cover all or part of the way to cover any future tax on gifts or inheritance.
I will discuss the two types of insurance policies that can cover CAT liabilities but are not in themselves taxable. You can have a policy that combines the two.
Policies under section 72
These consist of insuring the life of the custodian and using the proceeds of the policy to cover inheritance taxes on his estate.
The cost of coverage will depend on age and will be considerably lower for married couples where coverage will cover the life of the longest survivor.
Policy proceeds, to the extent that they are used to pay inheritance tax, will not be taxable.
The conditions are:
â The plan must mention that it is subscribed under the provisions of article 72.
â The covered policyholder must be the person paying the premium.
â Typically, the level of life coverage on the plan should be at least eight times the value of the premium paid each year.
â Regular premiums must be paid for at least eight years.
â If you stop paying regular premiums even after the eight-year period, you cannot start over.
â The premium cannot increase or decrease by more than 50% during a continuous period of eight years, except as a result of a review of the plan by the life insurance company.
The table below shows the approximate annual cost of the premium for a couple of the same age who foresees a CAT liability of â¬ 250,000 for their son / daughter upon death.
The premium assumes the couple are non-smokers and that the policy will pay on the death of the longest survivor.
Policies under section 73
This offers a fiscally advantageous solution when a person wishes to transmit his assets during his lifetime and there is a certain exposure to gift tax on the part of the beneficiary.
This is a type of savings policy where the proceeds are used to pay donation tax and the proceeds itself is not liable.
So, for example, if a parent were to offer their son or daughter money or shares worth â¬ 500,000, that son or daughter would be liable for donation tax up to â¬ 162,000 after claiming their tax-exempt amount, which would result in a donation tax of â¬ 53,460.
By taking out an article 73 savings contract that would have a maturity value of â¬ 53,460 or more after eight years, the tax on the donation would be covered, while the â¬ 53,450 that the parent gave to the child to pay tax would themselves be tax free.
As with S72 policies, there are conditions such as: premiums must be paid for at least eight years; the person offering the gift must pay the premiums; and if you stop paying regular premiums even after the eight-year period, you can’t start over.
Another condition is that an existing savings plan cannot be used as the plan must be set up originally as a section 73 policy.
As these are mainly savings policies, the return on investment will be negligible in the current low interest rate environment.
The eight-year minimum savings / premium requirement means that long-term planning is essential.
People who wish to bequeath part of their estate during their lifetime or those who foresee an inheritance liability for their children should do a quick assessment of their situation in order to determine the measures to be taken immediately rather than waiting for the event to be imminent. . .
Martin O’Sullivan is the author of the ACA Farmers Handbook and is a Carrick-on-Suir-based agriculture and tax consultant; www.som.ie