Protect Your Children from Inheritance Tax on Assets
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One major concern for any parent or business owner is the potential for their children to be burdened with significant tax bills on inherited assets.
Consider the example of someone inheriting a house only to find that the inheritance tax is so expensive that they cannot afford to pay it.
Lacking the necessary funds, they may be faced with the difficult decision of selling the property just to settle the tax bill with Revenue. This scenario often occurs unexpectedly, leaving beneficiaries in a tough position, having to part with cherished family assets to meet tax obligations.
If there’s a chance your children will face inheritance tax upon your passing, taking steps to safeguard them against this possibility in advance could be wise.
What is inheritance planning, and why is it important?
Inheritance planning, a key component of broader estate planning, specifically focuses on distributing assets to your family upon your death.
It ensures that your assets are transferred smoothly, efficiently, and in a manner that supports the financial well-being and future of the beneficiaries.
By carefully planning inheritance, you can avoid unnecessary complications, reduce the burden on your loved ones, and ensure that your legacy is preserved and passed on according to your desires.
What is Capital Acquisitions Tax?
Known as inheritance tax, CAT, or Capital Acquisitions Tax, is the tax you pay on a gift or inheritance.
The CAT rate was 33% when this article was written (as of April 2024). Spouses or civil partners are exempt from Capital Acquisitions Tax.
Categories of CAT – Inheritance Tax and Gift Tax
Inheritance Tax
Upon Death. This tax is applicable when inheriting any property from a deceased individual.
Gift Tax
Outside of death. This tax applies to any benefit received from an individual during their lifetime.
CAT – Group Thresholds
The Capital Acquisitions Tax (CAT) amount you must pay depends on your relationship with the individual providing the benefit. There are three distinct categories or groups.
If your children are set to inherit your assets, the Group A threshold will be applied when calculating Capital Acquisitions Tax (CAT).
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Ways to Protect Your Children from Inheritance Tax
Section 72 Life Insurance Policy
Section 72 life insurance is crafted to shield your children from the financial strain of inheritance tax.
It guarantees a payout in the event of your passing, equipping your children with the funds necessary to manage any tax responsibilities that arise.
This means your children can inherit your estate without the need to liquidate assets to pay taxes.
Example:
Background
Kate, a single mother, has always been mindful of the future and the legacy she will leave for her son, John, who is 25 years old. She owns a family home valued at €600,000, where John has grown up and which she intends to leave to him.
Scenario
When Kate passes away, John inherits the family home. However, with the inheritance comes a substantial inheritance tax bill. Based on the value of the property, John faces an inheritance tax liability of €87,450 to the Revenue Commissioners.
John, who is not in a position to afford such a significant tax bill, is faced with a heartbreaking decision. He might have to sell the house he grew up in, just to settle the tax liability.
Solution
Thankfully, Kate had the foresight to set up a Section 72 life insurance policy specifically for this scenario. Recognising the potential financial burden that could fall on John, she took out a policy to cover the estimated inheritance tax bill.
Outcome
Upon Kate’s passing, the Section 72 policy pays out a sum of €87,450, designed specifically to cover the inheritance tax bill.
This means John can keep the family home without having to worry about how to pay the inheritance tax.
Qualifying for Section 72 coverage involves adhering to certain conditions:
- The policy owner is obliged to cover the premium payments.
- Married couples or civil partners have the option of a joint-life policy.
- To access the intended advantages, the policyholder is required to consistently pay premiums for a minimum of eight years.
- If the insured passes away within an eight-year period, it is considered a standard life insurance policy.
The benefits from this policy are not subject to inheritance tax, assuming they are directly applied towards settling inheritance tax dues.
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Dwelling House Relief
Dwelling House Relief offers a way for beneficiaries to inherit or receive a property as a gift without paying Capital Acquisitions Tax (CAT), but only under strict conditions.
Some of the conditions include:
- The property must have been the deceased’s sole or primary residence.
- The beneficiary must have resided in the home as their sole or primary residence for the three years leading up to the inheritance.
- The successor is required to maintain the house as their sole or primary residence for six years following the inheritance.
- The individual inheriting the house must not own or hold an interest in any other residential property.
Notably, this relief can also be pertinent for a child who has been permanently and totally incapacitated. Such specific conditions ensure that the relief targets beneficiaries genuinely in need of support, reflecting the relief’s intent to alleviate financial burdens under specific circumstances.
Tax-free gifts
The small gift exemption, allowing annual tax-free gifts of €3,000, offers a strategic way for you to transfer wealth without incurring Capital Acquisitions Tax (CAT).
Each person can receive this €3,000 exemption from multiple donors per year, meaning a couple could collectively give €6,000 to each recipient every year.
Such gifts, which don’t count towards the tax-free threshold, highlight the importance of integrating all available reliefs into inheritance planning, potentially reducing the overall tax burden on an estate.
Parents and even grandparents are adopting this strategy to provide financial stability for the future generation. For example, this approach can help fund your children’s college expenses or assist them with securing a deposit for a home.
Tax bill savings strategy for your children
Known as Section 73, this savings policy allows you to save money in a way that the proceeds can be used by your children to pay off inheritance tax related to gifts.
This policy encourages you to save over a minimum term of 8 years, with the benefit of being tax-efficient when the term concludes.
This is great for parents who wish to pass on to their children valuable assets now, like a home or a part of a family business, without having to pay a large tax burden. It ensures that the child receives a larger portion of the gift’s value than Revenue.
A Section 73 savings policy designed to cover future gift tax obligations is not subject to Capital Acquisitions Tax (CAT).
The main conditions include:
- The policy must be specifically established under Section 73 of the Capital Acquisitions Tax Consolidation Act 2003 with the intent of paying taxes.
- It requires at least 8 years of premium payments.
- The policy should be held in one individual’s name, although married couples or civil partners can hold it jointly.
- The policyholder is responsible for premium payments.
- The funds must be used to settle gift tax for a gift given within one year after receiving the policy proceeds.
- If the policyholder passes away before completing the minimum 8-year term or before the gift tax is settled, the policy’s proceeds will be included in their estate.
- If there’s any excess after paying the gift tax, it stays with the plan owner, since it’s their money.
- If you stop making regular payments, even after eight years, you cannot resume them.
- Your premium cannot increase or decrease by more than 50% within any given eight-year period.
Agricultural Relief
If your children inherit or are given agricultural property, they might qualify for Agricultural Relief. This can significantly reduce the taxable value of the property, including land, by 90%, but there are certain conditions they need to meet.
To be eligible for Agricultural Relief under the ‘Farmer Test,’ the agricultural property must make up at least 80% of the total property value at the time of valuation. However, this rule does not apply to properties solely consisting of trees and underwood.
For gifts and inheritances given after January 1, 2015, with a valuation date on or after this date, the recipient must either:
- Farm the agricultural property on a commercial basis for a minimum of six years from the date,
or
- Lease the property for commercial farming to someone else for at least six years starting from that date.
This relief makes it easier to pass on farms from one generation to the next without incurring excessive tax obligations.
Business Relief
If your children inherit your business, they could qualify for business relief, potentially reducing the taxable value of the business by up to 90% when it’s passed on to them.
This is crucial for business owners looking to pass their life’s work to their children without forcing them to sell the business to cover tax bills.
To be eligible, they must keep the business for at least six years and meet certain conditions. Not doing so might lead to a clawback of the relief.
Have more insights about Business Relief by reading our article, “How Business Relief Can Help You Reduce Gift or Inheritance Tax“.
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Approved Retirement Funds (ARF)
If you’re retired, transferring your assets into an Approved Retirement Fund (ARF) can offer a more tax-efficient way to pass wealth to your children, especially when considering the differences in tax treatment based on the age of the child (under or over 21) and the nature of the tax (Capital Acquisitions Tax, CAT, versus income tax).
Here’s a breakdown of why an ARF might be more beneficial:
For Children Under 21:
Direct Inheritance: Children under 21 are subject to CAT on amounts above the Group A threshold of €335,000 at a rate of 33%. Children under the age of 21 are exempt from income tax.
ARF Advantage: While the direct benefit of transferring to an ARF might not seem immediately evident for children under 21 due to the same treatment for income purposes, the strategic withdrawals from the ARF could still be planned around tax efficiencies in future years as the child ages.
When you retire, there is a probability that you won’t have children under the age of 21.
For Children Over 21:
Direct Inheritance: Any inheritance over €335,000 is taxed at 33%. This is a significant rate that applies regardless of the child’s other income.
ARF Inheritance: Inherited ARF funds are subject to income tax rather than CAT. If a child over 21 inherits an ARF, they pay income tax on withdrawals. Children over the age of 21 are subject to a flat rate of 30% income tax.
For more insights, read our article, What Happens To Your Pension Plan When You Die?
Favourite Nephew / Niece Relief
While not directly for your children, if you’re considering leaving business assets to a niece or nephew, the favourite nephew or niece relief allows them to inherit as if they were your own child, enjoying the same tax-free thresholds and reducing their tax liability.
For this special treatment, the niece or nephew needs to meet certain requirements. The relief applies to only one niece or nephew who has worked for you or your spouse for the last five years.
They must have contributed at least 15 hours weekly in a small business or 24 hours in a larger one.
Meeting these criteria allows the niece or nephew to be considered under Group A for Capital Acquisitions Tax, raising their exemption limit to €335,000 for gifts and inheritances of business assets. This higher threshold acknowledges their significant contribution to the family business.
For further details, you might want to read our article, “Favourite Nephew/Niece Relief: Inheritance Plan for Business Owners.“
Planning is Key
Inheritance planning is crucial for anyone who values their children’s financial well-being.
Whether you’re considering the allocation of assets while you’re still alive or making arrangements for or after you’re gone, taking proactive steps is essential for securing your children’s future.
By thoughtfully planning your inheritance, you not only ensure that your assets are distributed according to your wishes but also minimise potential financial burdens on your children, helping them maintain stability and security in the years to come.
It’s important to remember that we are not only talking about reducing taxes; it’s about ensuring your legacy is transferred in line with your desires, offering both security and peace of mind to you and your loved ones.
At True Wealth, we are dedicated to guiding you through the intricacies of the tax landscape, helping you make informed decisions that align with your family’s unique needs and aspirations.
We are also experts in personal and business protection, savings and investments, pension tracing, personal and business financial planning, mortgages, and wealth management and extraction.
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All our content has been written or overseen by a qualified financial advisor. However, you should always seek individual financial advice for your unique circumstances.
