A significant transfer of wealth is on the horizon as Ireland’s population ages, yet only half of high net worth families have sought professional advice about how to plan for the distribution of their assets – either during or after their lifetime.
According to new original research by Goodbody, most wealthy families are highly motivated to pass on wealth in the most tax-efficient manner possible, however many are not taking the necessary steps to put this motivation into action by making a financial plan for inheritance.
Even among families who have taken advice, only a minority have shared their inheritance plans with their children – despite children being considered overwhelmingly the most important intended beneficiaries.
When we noticed this reluctance to move from intention to action and have ‘the awkward chat’, we realised there was a major gap in the available financial planning advice around inheritance. If we could address the subject comprehensively, we could help people talk more openly about it and, more importantly, plan their financial legacies more effectively.
The result is an in-depth report, Death and Taxes, that lays out a wide-ranging framework for understanding the complexities of inheritance, from managing assets and tax exposures to preparing the next generation to acquire wealth of their own.
- An assessment of how wealth in Ireland is moving between generations.
- Straightforward guidance on managing gift and inheritance taxes for major asset classes.
- Options for ‘giving while living’.
- How to pass on property in a tax-efficient manner.
- Ideas for tackling business succession and transferring farm ownership.
"Our research and experience with clients show that people are giving a lot of thought to inheritance but aren’t necessarily following through by making a clear plan,” said Simon Howley, Goodbody’s Head of Wealth Management. “We know that people want to avoid paying more tax than they have to, so moving from intention to action is vital."
We have seen time and time again cases where, with some financial planning and structuring, we could have helped families with significant wealth reduce their tax bills, more easily transfer an asset or speed up and simplify the inheritance process. Death and Taxes shows the significant impact that estate planning can make in people’s lives and maps out some of the options families have for dealing with their finances – both before and after a death. A little forethought and preparation can help preserve wealth and income for both loved ones and future generations.
To learn more about inheritance tax rates in Ireland, go to www.revenue.ie
Longer life expectancy is making this more urgent for our clients. Many of them want their adult children to benefit from their wealth today, when it is needed most, rather than waiting for inheritance, which can come long after the children start families of their own. That means seeking advice and mapping out strategies.
There are several mechanisms parents can use to engage in early gifting. The five most common are highlighted below.
Under current legislation, parents can give a child gifts or an inheritance of up to €310,000 tax-free (the Group A threshold) before the child owes any Capital Acquisitions Tax (CAT). This threshold is cumulative, so all the gifts and inheritances received since 5 December 1991 must be counted when calculating whether the threshold has been reached. The standard rate of CAT for gifts and inheritances received above this threshold is 33%. If used to the full extent, the CAT tax-free threshold is worth up to €102,300 in tax saved to a child who receives a gift or inheritance from a parent.
Small gift exemption
There is one small exemption from CAT that can make a considerable difference over time, if applied early enough: the small gift exemption. This exemption allows people to transfer wealth easily and incrementally in the form of annual €3,000 tax-free gifts. Parents and grandparents are increasingly doing this to help the following generation get a start in life - for instance to help fund childcare costs or provide a deposit for a property. This practice is especially meaningful as life expectancy improves and the next generation is reaching middle age before inheritance becomes a realistic possibility.
Anyone can receive a gift of up to €3,000 from any other person in a calendar year without having to pay CAT. Gifts can be taken from multiple people, as well, and the same €3,000 exemption applies to all of them. That means that parents and grandparents can separately give €6,000 (as couples) to each child/grandchild (or any other person) every. Such gifts could potentially accumulate year by year into a substantial tax-free sum, underlining the value of planning and incorporating all available reliefs into any inheritance plan. These exempt gifts are also excluded from calculating whether the tax-free threshold has been reached, meaning the tax liability of the remaining estate on inheritance is unaffected by giving them.
Payments for support, maintenance or education
Monetary gifts to minor children or adult children up to age 25 who are in full-time education can be exempt from CA, provided the amount represents a normal expenditure for a person in their circumstances as well as a reasonable outlay for the person making the gift.
Dwelling House Relief
Normally, standard CAT rates apply to property transfers to children over the available tax-free thresholds. However, under Dwelling House Relief, a property can be gifted without the beneficiary having to pay CAT, in very limited circumstances. Restrictive conditions must be met to avail of this relief, however. The main ones are that the beneficiary must have lived continuously in the house for three years prior to the gift and not have an interest in any other dwelling house. The relief may be applicable for a child who is permanently and totally incapacitated or a dependent relative.
Paying CAT bills on your children’s behalf
For a parent wishing to help a child during their own lifetime and looking to structure their succession plans tax efficiently, Section 73 plans can be very useful. This relief is a valuable succession planning instrument that can offer the option of paying a child’s (or any beneficiary’s) CAT bill on a gift without the payment itself being considered a further taxable gift. Effectively, use of Section 73 plans means that less of the asset value is used to cover tax costs - and more of it goes to the intended beneficiary.
Section 73 relief simply entails investing in an insurance policy, such as a qualifying investment savings plan, for a minimum of eight years from the date on which the policy is effected. After that period, a parent is free to cash in the proceeds to settle their child’s gift tax liability. Depending on the value of the assets being transferred, the relief can mean a substantial difference in the ultimate cost to fund the tax. The proceeds must be used within one year of the policy maturing to pay gift tax for those proceeds not to count as a gift for tax purposes.
Section 73 and property
Gifting property assets early can come with both practical and tax-efficient outcomes. A property gift made alongside a Section 73 plan provides the child with a property and a means to fund the gift tax liability. Significantly, future capital appreciation on that property will accrue to the child, for whom no further charge to CAT will arise, rather than in the hands of the parents. This can work especially well when the asset being gifted does not attract a Capital Gains Tax (CGT) liability and where the Stamp Duty liability may also be minimal. Section 73 can also assist in the tax-efficient transfer of family businesses and agricultural land to the next generation which would not otherwise benefit from CAT relief.
It is no surprise that property remains a huge component of wealth in this country. We have found that deciding what do with it is very important for most clients in their succession planning. Options overall are limited, but we have outlined the most popular ways that clients protect property wealth across generations.
Transferring the family home or a single residential property to a child
Normal Capital Acquisition Tax (CAT) rates apply in cases where parents wish to transfer a family home or single residential property to a child - with one significant exception. Under what is called Dwelling House Relief, a property can be gifted or inherited without the beneficiary paying tax, provided that certain stringent conditions are met.
Currently, this limited exemption applies to beneficiaries who 1) have lived in the dwelling house as their only or main residence continuously for three years immediately preceding the date of the gift or inheritance and 2) do not have an interest in any other dwelling house at the date of gift/inheritance (in Ireland or abroad).
The beneficiary must continue to own and occupy the dwelling house as their main residence for six years commencing on the date the benefit is taken, otherwise the exemption will be clawed back. (This condition does not apply to a beneficiary who is 65 years or over on the date the benefit is taken.) Also, the dwelling house must have been occupied by the giver as their only or main residence at the date of their death or the date of the gift.
If parents are considering gifting a property during their lifetime to a child, the Capital Gains Tax (CGT) due can be credited against the CAT liability arising, provided the asset is not disposed of within two years of the date of the gift. Therefore, the parents may need to consider how the CGT liability from a transfer will be funded especially as no proceeds from the transfer will be available immediately to the parent or child to settle the tax liabilities arising, because we must assume that the child is not paying for the property.
Funding the tax liability on behalf of your children via an early transfer
Section 73 savings plans can be used to fund the gift tax due on the transfer of property assets to help adult children get on the property ladder without incurring an extra gift tax liability. Section 73 plans also allow for the early transfer of property that would eventually be part of any inheritance, but without future capital gains accruing. That means (assuming increasing property values over time) a smaller tax liability on the same asset due to the timing of the transfer.
Transferring property via inheritance using a life assurance policy
A Section 72 life insurance plan is a policy to cover the inheritance tax bills of the beneficiaries of your estate. It allows those beneficiaries to inherit assets without then having to find the money to pay a significant tax liability. This might be useful where the beneficiary does not want to sell assets to pay their tax bill or it is difficult to do so quickly - for instance, if they inherit property. Any proceeds of the Section 72 policy not used to pay inheritance tax will be subject to CAT, however.
Inheritance involves a two-way relationship between a giver and recipient. In Ireland, where parents are the primary source of gifts and inheritances for most households, that relationship tends to be between a parent and child. In fact, more than three-quarters of households with at least one member aged 45 or older has either received a gift or inheritance or is expecting one. And the wealthier a household is, the more likely at least one member will receive an inheritance, with more than 50% of people in the top wealth decile reporting either getting or expecting a gift or inheritance from their parents - far higher than any other income group.
The data is clear: the dispersion of wealth in Ireland is from parent to child while wealth accumulation and economic mobility from one generation to the next hinge significantly on inheritance. It is not surprising that this is the case. What comes through most strongly in our conversations with clients is a desire for financial security - both in terms of providing for old age and providing for their children.
Given how fundamentally inheritance influences wealth and financial outcomes for the beneficiaries, one would expect that children are as involved in estate and inheritance planning as their parents. After all, the children have the most to gain or lose from managing the process as effectively as possible. Yet at Goodbody we have seen time and again that educating and preparing the beneficiaries of inheritance to receive wealth remains largely an untouched area.
Having the talk
Our research shows that many parents have not shared the full details of their plans with the next generation. One story we hear frequently from clients is that they are not, in fact, passing wealth on to the next generation at all, but rather leaving it to their spouse, who they believe is in a good position to manage the estate themselves. That may be true in the short term, but it is not a long-term strategy. The inheritance will end up with the children eventually.
We also come across clients who believe that their children are fortunate to be receiving an inheritance at all and, therefore, can sort out any tax bills themselves. Equally, children don’t want to appear greedy or ungrateful by proposing inheritance planning strategies of their own. There is just a taboo around talking about inheritance within families. And it can be awkward to broach the topic, which is why seeking advice and an independent facilitator is so essential.
This dynamic is so difficult to manage because there is an essential conflict between giving money and assets on the one hand and withholding information on the other. Increasingly, our in-house tax experts are asked by parents to chair meetings with children or other intended recipients of gifts or inheritances. The aim is to objectively inform the children of the financial position, the proposed course of action and the planned distribution of wealth so they can absorb the information and ask questions of an independent expert source.
Our experience leads us to believe that children and other beneficiaries should educate themselves and equip themselves with knowledge to help their parents make these important decisions or even, where appropriate, take over the planning. That means replacing the central conflict between giving and withholding with a commitment to dual caretaking. We are starting to see cases whereby adult children of clients are seeking meetings alongside their parents to get up to speed on the issues surrounding inheritance planning. Such meetings are at the discretion of parents, of course. But as much as it makes sense to intelligently structure wealth that you create during your life, having a plan for receiving wealth through inheritance is the sensible thing to do, as well.
The extent of the tax-free threshold available depends on the relationship between the beneficiary of a gift or inheritance and the person giving the benefit. Generally, the closer the family relationship between the persons involved in the transfer, the higher the allowable threshold. All gifts and inheritances received since 5 December 1991 from the giver within the same group threshold are aggregated to determine the amount of tax-free threshold available. Any excess benefit received above the available threshold is subject to CAT, currently at a rate of 33%.
Since 1 December 1999 a charge to CAT will arise where:
- the giver is resident or ordinarily resident in Ireland; or
- the beneficiary is resident or ordinarily resident in Ireland; or
- the gift or the inheritance is of Irish located (situate) property.
The diagnosis of serious or terminal illness signifies one of those life events where financial advice is critical. Yet, understandably, when someone finds themselves in such circumstances, financial matters typically get pushed far down the priority list in favour of health care. However, understanding what steps you can take to preserve wealth can significantly improve the financial outcomes for you and your beneficiaries.
Most clients we encounter are unaware of the technical provisions - especially around pensions - that can help in these situations and so are not able to protect their wealth as effectively as possible. We have found that proper guidance and planning can make a meaningful difference.
Preserving your active pension
When you are an active member of an occupational pension scheme, the lump sum payment on death is limited to four times your salary (or final remuneration). However, if you 'preserve' the pension, you will be entitled to a death benefit equal to 100% of the value of the fund. Where the value of your fund is greater than four times salary, it could therefore make sense to preserve the pension benefit, allowing more money to be paid out to your beneficiaries. Leaving employment is one possible way of preserving your pension. In any case, a considerable amount of planning can be undertaken to ensure that the death benefit treatment is maximised in either circumstance.
Death's door concession
This concession is used very infrequently, yet it may have applications in certain circumstances. If your illness is terminal (where life expectancy is measured in months rather than years), Revenue allows your entire occupational pension pot to be drawn down at a concessionary income tax rate of 10%. The difference between this rate and the rates of income tax, USC and PRSI (up to 55%) is substantial.
Death is not a benefit crystallisation event
A large minority of wealthy pension investors get caught by the €2 million pension fund threshold where a liability to chargeable excess tax of 40% materialises on retirement. Those with pension pots exceeding €2 million in value get charged an extra 40% on top of the marginal rate of income tax, USC and PRSI. The threshold is meant to put a hard cap on pension saving and the associated tax relief.
This excess tax liability is extinguished on death, however. Therefore, there may be scope to use this mechanism to pass wealth effectively in situations of terminal illness.
Marriage continues to be one of the most powerful tax planning mechanisms, because it eliminates exposure to CAT for the spouse. Co-habitation does not necessarily eliminate that exposure. In instances where the couple are not married, the partner benefiting from an estate would have to pay 33% CAT on the value of the assets above €16,250 - the lowest CAT threshold. As a spouse, however, he/she will not have to pay anything, thereby preserving the wealth of the estate.
Irish law governing the tax treatment of business and farm succession recognises the importance of small and medium sized enterprises to the Irish economy. Accordingly, the two constituencies with the most options for optimising their tax position for gift or inheritance purposes are business owners and farmers. Despite the relatively favourable treatment within the tax system, transferring a business introduces another layer of complication to the gift or inheritance process.
We believe it is important for business owners to take an integrated approach to developing tax-efficient exit plans as well as ensuring their personal pension is optimised post-transfer. When we sit down with a business owner who is considering passing on their business asset to the next generation, we make a detailed financial plan. Our starting point is to focus on the individual and their personal financial position - both today and into the future.
Time and time again, we see scenarios whereby an individual has not made adequate provision for their own future income needs following a business transfer - especially when that transfer is to a child or children and, therefore, there will be no proceeds for the business owner from the disposal. Where business assets are a principal component of wealth, it is imperative that an individual seeks adequate advice early on how they might extract enough value from the business asset to fund their own future lifestyle before any sale or transfer to children. This can be through a variety of mechanisms such as:
- Pension funding.
- Pension fund threshold management.
- Termination payments.
- Company buy-back of own shares.
So when a business owner is considering exiting or passing a business on to the next generation, achieving that in a tax-efficient manner may be a key objective, but personal financial planning should not be overlooked.