Death and taxes: five ways to reduce the tax bill on your estate
Inheritance thresholds for a child have plummeted since 2009 but there are ways to avoid or mitigate tax bills
The tightening of inheritance tax rules may have started in 2009, but it is only now, as property and asset prices recover, that people have started to wake up to the importance of the changes.
“People aren’t aware of it and people don’t understand what’s going to happen,” says financial adviser Derek Maguire of Financial Architects.
The thresholds for a child have plummeted from more than €540,000 in early 2009 to just €225,000, while the rate of capital acquisitions tax has soared from 20 per cent to 33 per cent.
It may not be unusual for someone, particularly in Dublin given the recovery in property prices, to have an estate of €1 million, the tax implications of which can be onerous, depending on the number of children the couple has.
Figures from the OECD show Ireland has one of the toughest inheritance tax regimes in the world.
In the UK, for example, the threshold is £325,000 (€454,000), although this is the tax free limit on the entire estate, not on inheritances by an individual. Given the impact of taxes and the low thresholds, someone could now stand to lose up to 25 per cent of the money they inherit on taxes.
The impact is most keenly felt in Dublin. The Revenue collected €168.3 million in inheritance tax from Dublin-based taxpayers last year, more than half the total of €327.95 million collected nationally.
It can also put pressure on people to try to settle a tax bill at a time when they may be distraught after suffering bereavement.
Capital acquisitions tax must be paid by a deadline of October 31st for gifts/inheritances valued in the previous 12 months.
According to Andrew Fahy, tax and financial planning director with Investec, “The key thing is not to ignore it.”
It’s an area to which the Revenue Commissioners are paying close attention. The Revenue says between 2013-2014 it investigated about 750 cases involving capital acquisitions tax, and these resulted in an additional yield of more than €20 million, or an average of €26,666 per case.
“Keep a record of transactions,” says Fahy, as you will be asked to disclose these details on the IT38 form.
“It’s a self-assessment system, so it’s up to the individual to submit the return correctly,” he says, adding that if you run into problems, there is an option to spread repayments. According to the Revenue, you can opt to pay capital acquisitions tax on gifts or inheritances by monthly instalments over a maximum five years, but interest at a rate of 8 per cent a year will be levied on the balance, and is payable with each instalment.
Calls have been made from a number of quarters for a significant increase in the thresholds. Fianna Fáil says increasing the parent-to-child threshold to €300,000 would cost the exchequer €36 million but would “significantly relieve the pressure on families at a time of huge emotional distress”.
Fahy says there have been “murmurs” that a move to the increase threshold might come in this year’s Finance Bill or budget.
Until then, any taxes that might arise on your death can be avoided or mitigated in a number of ways. As Maguire says, “You pay tax most of working life – the last thing you should be doing when you die is paying more tax.”
1 SPEND YOUR MONEY The simplest way of not leaving your family with a hefty tax bill is to not leave them any money – or at least nothing in excess of the thresholds.
This means if you have money, you should be increasing your weekly allowance, and throwing caution to the wind by increasing your holidays, meals out and home renovations.
The problem, of course, as Maguire says, is “most people are afraid to spend it” – and rightly so in many cases.
First of all, none of us knows for sure when we are likely to pass on, and so we cannot gauge accurately how much of our assets we need to conserve, especially if an annual pension needs subvention from other assets.
Giving money away is always an option, but even this can be liable to tax, as was clarified last year, when the Finance Act tightened the definition of what could be considered to be “support” to children.
“The reality of the post-financial crisis in Ireland, is that there are a lot of parents who are helping their children out in various ways who fear now that everything has been caught in the gift or inheritance tax regime,” says Fahy.
One way of getting money to your nearest and dearest without affecting their thresholds is the €3,000 annual small-gift exemption. This can be a convenient way of handing over money without incurring a tax bill.
For example, a couple could give their daughter and her family up to €30,000 every year if she has three children (€3,000 from each parent for the daughter, the son-in-law and three children). You “can’t backdate or postdate it – you use it [in any given year] or lose it”, Fahy warns.
This approach has potential pitfalls, particularly if your assets are tied up in pensions or property.
“Not everybody has €6,000 to be paying out every year,” says Fahy, and your children may also not be of an age at which you feel comfortable giving them so much money.
2 SET UP A TRUST Another option is to set up a trust fund. According to Maguire, availing of such a structure can be useful when someone has cash they don’t need. If this is the case, they can put funds up to the child threshold of €225,000 into a trust fund, and allow it to grow.
After 20 years, for example, the fund might be worth three times the original threshold – but the child won’t incur a tax bill on it.
3 MOVE THE CHILDREN BACK HOME If you have children and fear they may face taxes due to the size of their estate, you could consider availing of family-home relief as a way of preserving their exemption thresholds.
Under this relief, if a child lives in the family home for three years leading up to the gift or inheritance (and has no other property themselves), the parent can then gift it to them tax free, as long as the child then stays in the property for six years after the handover and doesn’t own other property in that time.
Certain nuances can make it less restrictive. Consider the example of a couple who have a family home worth €550,000 and an investment apartment worth €250,000. With just two children, each is likely to face capital acquisitions tax on assets of about €175,000 (allowing for the tax-free threshold of €225,000 applying to each one of them).
If, however, one of the children moved into the apartment with their partner, and stayed there for three years, the parents could then gift the apartment to that child, and they wouldn’t be liable to any capital acquisitions tax. And, while ostensibly she’s supposed to stay in the apartment for a further six years, a trading-up clause in the relief would allow her to sell the property and trade up to a larger home straight away.
Moreover, another tax point to note is that if the young couple weren’t paying market rent of, for example, €1,000 a month, this could be covered under the €3,000 annual gift threshold, so a tax liability shouldn’t arise for this either (ie €3,000 from each of the parents to each of the couple amounts to €12,000 in the calendar year).
According to Fahy, use of this relief is fairly limited. “I don’t think enough people know about it,” he says.
4 GET AN INSURANCE POLICY If you don’t want to leave your children with a significant tax bill in the event of your death, you could always buy an insurance policy which will cover this sum in the event of your death.
Known as a section 72 policy, the relief is approved by Revenue to allow people cover the cost of death taxes. “The advantage of this is that the proceeds of the policy is not in itself a taxable event,” says Fahy.
It is structured as a whole-of-life policy but can be expensive, costing about €8,000-€10,000 a year, depending on the amount to be insured.
It could be something that the children are asked to cover the cost of, says Maguire, given that it will help them avoid taxes when they inherit. And there are some restrictions. For example, with these policies you must continue to make regular premium payments for at least eight years, and, if you stop, even after these eight years, you can’t restart again.
You can also get a policy to cover the cost of gift tax, known as a section 73 policy.
5 GET ASSET ALLOCATION RIGHT It’s also worth considering to whom you should leave certain assets, if you are in a position to do so, as there may be more tax advantages in passing on certain assets to someone who is bound by the thresholds than to a spouse.
People tend to forget that you can get credit for capital gains tax against capital acquisitions tax , says Fahy. If you have an asset that you want to sell, and on which you’re going to pay capital gains tax, you could look to gift that to someone who will have capital acquisitions tax to pay, such as a child who has already reached their threshold, or someone else. Doing so will mean that while you pay 33 per cent capital gains tax on the proceeds of the sale, they can get the capital gains tax credit, which will lead to a smaller capital acquisitions tax bill.
Another consideration is fund investments subject to exit tax at 41 per cent. Again, someone who is liable to capital acquisitions tax can get credit on this which would reduce their tax capital acquisitions tax bill. This means it may be more favourable to leave such investments to someone who is subject to capital acquisitions tax, rather than a spouse. If you had an investment in shares, on the other hand, it may make sense to leave this to your spouse, as capital gains tax dies with you.
“These are good reasons for people to look at efficient will drafting,” says Fahy.