Inheritance tax issues for co-habiting couples

Are you one of the 150,000 householding in Ireland who are co-habiting? Are you aware of the potential Inheritance Tax consequences of Life Insurance which is incorrectly set up?

Recently, when reviewing the life cover of clients who were an unmarried couple with young children we discovered that their Protection policy was incorrectly structured and would have resulted in an Inheritance tax bill if either of them were to die.

These co-habitants can now legally claim from their deceased cohabitant’s estate. However, unknown to many of them is that inheritance tax still applies and in the eyes of Revenue they will be classified as “strangers” meaning they will only have a Group C lifetime Inheritance threshold of €16,250.

If you are part of a cohabiting couple, there are a number of important points you need to be aware of when taking out a Life Insurance policy. If you arrange a life Insurance policy on your own life, your surviving partner may be left with an inheritance liability. If the survivor is deemed not to have paid premiums, problems arise!

What would the inheritance tax situation be if Mary were to die? Unfortunately for John, as Mary has paid all the premiums, he is deemed to inherit the whole €200,000 from Mary and has to pay inheritance tax on it. Assuming he has not received any other assets under Group Threshold C previously, his tax liability is: €200,000 - €16,250 x 33% = €60,637,

If John could prove he’d paid for half of the premiums out of their joint account, this would help reduce the tax liability by half, as it’d be assumed he’s inherited half of the sum insured. €100,000 - €16,250 x 33% = €30,318. Either way, John is left with a significant bill to pay Revenue within a certain time frame.

So, what is the best solution for a cohabiting couple?

1. ‘Life of Another’ Solution

A more appropriate structure would be for John & Mary in our example to take out 2 separate life Insurance policies under a ‘life of another’ arrangement. This means that each of the policies is owned separately, clearly identifiable and there should be no future Inheritance Tax liability as they each pay for their own policies. If as in our example, John is unemployed and unable to pay the premium, this can be solved by Mary using the Annual Small Gift Tax Exemption by ‘gifting’ the premiums to John. This Small Gift Tax exemption allows for €3,000 a year to pass from any one person to another, so if the premiums are below €3,000 a year, John can claim the premiums were gifts. Therefore in this new scenario where Mary was to die, John receives the proceeds of the policy he owns without any liability to inheritance tax.

2. The ‘Section 72’ solution

Alternatively, each of them could take out a separate Section 72 life insurance policy to pay off any inheritance tax liability, such policies are exempt from inheritance tax insofar as the proceeds are used to pay inheritance tax. This arrangement may be more important to cover any tax liability for the dwelling house in which the couple are living. For John & Mary, if they buy a house in joint names and one of them dies, the survivor may have a liability to inheritance tax on the value of the house (assuming the house is held as joint tenants).

However in this case they may be able to avail of the Dwelling House Exemption. The Dwelling House Exemption provides a complete exemption from inheritance tax on the value of their home, provided certain conditions are met. It is not unusual for cohabiting couples not to meet the necessary criteria and therefore face a Tax bill.

In conclusion, life cover for co-habiting couples is a complicated area, it can prove very costly if you have the wrong type of cover, always seek Independent professional advice.