The circumstances around receiving an inheritance can mean that you already have a lot on your mind. It’s not easy, but it’s important to educate yourself about the wealth you are going to receive. In the second instalment of a three-part series, we present some tips for those expecting an inheritance – from what to do with it to who pays the tax bills.
Receiving an inheritance probably means coping with the death of a loved one. It’s a difficult time – some may be aware of what assets they stand to receive (see 'Inheritance planning: why conversation is critical’ for more information), while for others making decisions about an inheritance can be challenging.
Either way, here’s what you should consider if you’re expecting an inheritance.
1. Educate yourself
It is imperative that the next generation educate themselves on the most important elements in relation to inheritance. Start with what the rules are. What are you entitled to tax-free? What assets will attract a Capital Acquisitions Tax (CAT) liability, and when will you be expected to pay it? Are there penalties if you don’t have funds to pay it on time? What if you need to sell a property or other assets to fund the bill? Should you ask your parents to give while living versus waiting for an inheritance?
If you understand what you might receive – the value of any assets and the taxation rules that pertain to the transfer – you are automatically in a better position ahead of time to consider the following:
- Funding the bill
A CAT liability may be due on the gift or inheritance. Are there adequate resources to cover this (potentially large) tax bill? Do you need to sell or mortgage assets to cover it? If so, what are the best assets to sell for your own long-term financial position and wealth?
- Your own financial planning
If you are set to inherit a sum of wealth, what is the best use of that windfall? Where are you in your own financial life? Do you have a pension? Have you sought advice on how best to invest it? Do you have the capacity to take on significant risk? Should you pay down debt?
- Dual caretaking
As people age, roles in families evolve and adult children might bear the responsibility of giving advice and providing input regarding family finances. By educating yourself as to the most appropriate inheritance strategies available that may or may not be suitable for the distribution of your parents’ wealth, you’ll be able to understand whether your parents are making the best decisions for themselves financially and personally.
2. Think of the grandchildren
One trend we see more and more is grandparents initiating annual gifting (of up to €6,000 annually per couple via the small gift exemption) to each grandchild to distribute wealth to help fund education fees and/or childcare costs.
Not only can this make a significant impact on the day-to-day financial burden of young families, but this contribution is equally meaningful to the giver.
In some cases, the second generation has already accumulated substantial wealth of its own and grandparents may wish to skip a generation when passing on assets, so that the same wealth – which ultimately would pass to the grandchildren anyway – is not subject to CAT twice.
3. Understand what planning tools are available
Section 73 savings plans can be a useful advance way of addressing cashflow concerns on CAT liabilities. The rules around them do state that savings plans need to be a minimum of eight years in duration.
Indeed, it matters to know not only what is out there, but how the available tools might help your family and what kind of forward planning you need to put in place to use them.
Before it is potentially too late, beneficiaries might consider informing or encouraging parents to simply ensure that their savings (or a portion of them) have Section 73 status. It doesn’t matter if your parents never avail of this tool but obtaining this status is relatively easy. In some instances, it might be an important source of income down the line.
4. Strategic liquidation
Education and knowing the rules will go a long way to help a beneficiary understand what they are able to do with the assets that they will potentially inherit.
For some, it can feel overwhelming, especially if the assets are complex, while for others, the asset allocation they are set to inherit is just not suitable for them.
Depending on individual circumstances, it may be worth discussing with parents the possibility of undertaking the early strategic liquidation of an estate so that an inheritance becomes cash and/or liquid assets.
That way, the beneficiary has a clean slate from which to seek professional advice about investing the funds in a way that is more appropriate to them and matches their own risk appetite and financial goals.
5. Mind the clawbacks
There are a few scenarios where the Revenue Commissioners could potentially seek to claw back the benefit of reliefs. Moreover, the child or beneficiary will be liable, so it is critical for beneficiaries to be aware of the rules that apply to certain reliefs:
- CGT/CAT offset: where CGT can be credited against a CAT liability arising, if the beneficiary disposes of the asset within two years commencing on the date of the gift or inheritance, the credit will be clawed back.
- Retirement Relief: children who are gifted a qualifying business asset should understand that there is a CGT clawback of that relief if the child disposes of the business asset within six years. In any such case, the CGT which would have been charged on the transfer if the relief had not applied is assessed and charged on the child. In addition, tax on any gain made by the child on his or her disposal of the assets will also be charged.
- Business Relief: this can also be clawed back if at any time within a period of six years commencing on the date of the gift or inheritance, the business is sold or ceases to be a qualifying business asset and is not replaced by another qualifying business asset within one year.
- Agricultural Relief: agricultural relief is subject to clawback if disposed of within six years from the date of the gift or inheritance and not replaced with other agricultural property within specific timeframes depending on the circumstances of the disposal.
- Dwelling House Relief: where a parent transfers a residential property to a child and meets the conditions to avail of Dwelling House Relief, the child should be acutely aware that they must continue to own and occupy that property for a minimum of six years commencing on the date of the gift or inheritance (subject to limited exceptions). Otherwise, the CAT exemption will be clawed back.
6. Have the talk
It is possible for a parent to give a direction in a will regarding a particular property or asset. For example, express wishes can be made about the disposal of one property or asset over another. This can be helpful where the next generation is made up of multiple parties with potentially conflicting views regarding the administration of an estate and the significance of one asset over another.
As part of the probate process, the personal representative must prepare a Statement of Affairs (Form SA2) which is a listing of every single asset in the estate. While jointly owned assets will transfer automatically, the rest are distributed at the end of the probate process.
Generally, no CAT on an inheritance needs to be paid until a beneficiary is in receipt of assets or cash. Yet once in possession of the assets, beneficiaries are liable for CAT, and if the valuation date falls within the 1 January to 31 August timeframe, CAT is due by 31 October of that year, leaving a short space of time to find the resources to meet the liability.
This can create an urgent need for cash which, if the beneficiary does not have it within their own resources, can effectively force the sale of assets to cover the tax bill.
To potentially minimise family conflict, it might be advisable for children to proactively discuss their preferences with their parents (in the first instalment of this series, we delved into the importance of transparency when it comes to inheritance planning). This can be especially important when considering the disposal of assets to settle any potential tax liabilities.
One option is to request that parents make a direction in their will ordering the personal representative to sell assets in advance and distribute cash as the inheritance, so there is less to argue over.
7. Act now
While CAT tax-free thresholds are low and there are limited options to mitigate tax in the transfer of many assets, the reliefs available in the transfer of business assets to the next generation can be significant.
It is always possible that existing tax legislation could change or in some circumstances be hugely curtailed.
In the case of family businesses, there may therefore be a stronger incentive to avail of the current retirement and business reliefs available today. Hence, transferring business wealth to the next generation might become a strategic imperative as significant tax costs are reduced under many current scenarios.
In addition, the CGT reliefs available for business owner parents passing on business assets (Retirement Relief) are optimal between the ages of 55 to 65 compared to any other time.
Children or beneficiaries may wish to engage in proactive dialogue with parents regarding how a transfer might be optimised from both a timing and tax perspective.
Not preparing for inheritance can have serious emotional and financial consequences later on – don’t wait, start the conversation early.
What would you like to do next?