Insurance can pay inheritance tax bills... at a price

I notice that you get a lot of queries about inheritance. I know it can be a very complicated area but I remember hearing about an insurance policy that you can get and you will not have to pay inheritance tax. Is that so and does it still exist? How does it work? Would it make sense for someone like me who does not have much in savings? My house will be the main thing that I leave to my two children. It is currently worth about €700,000.

– Ms GT, email

You remember right. And it does still exist. They are called section 72 policies, but whether they make sense to use is a different matter.

As you can imagine, given they cover a tax bill, these policies are tightly regulated and they are useful only to people with very large estates or whose beneficiaries would not have the wherewithal to settle an inheritance tax bill without, for instance, selling the family home that has been left to them.

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So how do they work?

Essentially, a section 72 policy is designed to meet some or all of an expected inheritance tax bill. However, while inheritance tax bills are paid by beneficiaries under Irish law, a section 72 policy is taken out by the person who currently owns them.

Yes, the people who pay the bill will derive no benefit from the policy for which they are paying the premiums. It is, as Nick McGowan of Lion.ie Life Insurance puts it, a case of you paying for the insurance to hand over a house that you already spent 35 years paying off a mortgage on.

As I said above, it makes sense only for a limited group of people. If the estate is particularly large, paying the premiums reduces the amount of assets exposed to inheritance tax in your death and therefore the amount that needs to be covered.

A lot of families would not have those cash savings lying around – especially with a mortgage and young children of their own

Separately, for those whose beneficiaries are cash poor, it allows parents, or whomever, to make sure that a prized family asset – such as the family home – passes on down the family without having to be sold to meet the tax bill.

If you consider a property worth €500,000 – and there is plenty of those in Dublin at least – that parents want to leave to their only child, it will be well in excess of the current €335,000 tax-free limit on inheritances from a parent to a child.

Even if there were no other assets inherited, the child would face a bill of €54,450 on the €165,000 by which the value of the property exceeds their tax-free threshold. A lot of families would not have those cash savings lying around – especially with a mortgage and young children of their own. The only way to meet the bill would be to sell the house. That’s what the section 72 policy avoids.

The key thing is, although the policy is taken out by the person who has died, it does not form part of their estate as long as it is earmarked for an inheritance tax bill. Instead it is paid to the executor or personal representative handling the dead person’s affairs.

What does it cost?

Well, it’s expensive, there’s no getting around that. There are two reasons for this. First, section 72s are guaranteed whole-of-life policies: they continue until you die regardless of what age that might be and they are not subject to the sort of endless upward revision of premiums that makes most regular whole-of-life policies impossibly expensive as one gets older. The flip side of that is that you do pay more for the cover from the outset than you would under policies where premiums can be reviewed.

Secondly, for couples, they most commonly pay out on a second life basis. When a person dies, their spouse can inherit everything from them with no inheritance tax issue. The tax issue only arises when the second person dies and their assets are passed on to other family members or friends.

We’re more used to policies, such as mortgage protection, which pay out on the first death in a couple.

Those factors aside, there are also the usual issues that impact life insurance policy premiums – your age, your lifestyle (do you drink or smoke), your health at the time you take out the policy and, of course, the amount of cover you’re looking for.

I asked Royal London to give me a few examples so that readers might get a sense of the cost involved. The key thing is to assess how much needs to be covered – and remember, it is not the value of the inheritance that you need to cover but the amount of inheritance tax that would have to be paid on it. The policy will pay out a set amount, though some providers do allow you to adjust this over the life of the policy.

If it is too low, some inheritance tax will remain to be paid. If it is too high – maybe because you sell some assets between now and then – the excess will be treated as an asset of the estate and subject to inheritance tax itself.

Naturally, if there are cash savings as part of the estate – or easily liquidated assets – you might not need to cover the full bill. Similarly, if the beneficiaries have their own cash resources.

In this case, we worked on the basis of a potential tax bill of €500,000, so it is clearly a big estate with €1.5 million of assets over and above the tax-free threshold. In all cases, these quotes are for policies paying out on second death.

For a couple aged 64 and 60, who are both relatively healthy with no illness or conditions, Royal London says they could expect to pay about €907.35 a month. That assumes neither smoke and that their alcohol consumption is within normal guideline levels, with no history of alcohol abuse.

Age, lifestyle or illness can increase those figures dramatically. For instance, a couple aged 72 and 70, where the older person smokes about 20 cigarettes a day and is in remission for testicular cancer for the past five years, would expect to pay about €1,855.67 a month, according to Royal London.

The big issue is affordability. If you stop paying the premiums, the cover dies and you're back to square one

The couple would need to have an otherwise clean bill of health from their general practitioner, including confirmation that there has been no recurrence of the cancer and that the second person covered has no lifestyle or increased medical risks.

If the smoker was the younger person in that same couple – the 70-year-old – and she was in remission for breast cancer by three years, they could expect to pay about €2,070.58 a month – more than €200 extra each month – with the other circumstances the same as above.

Is it worth it?

Well, if you’re the clean-living healthy couple of 64 and 60 above, your premiums amount to €10,888.20 a year. It’s an awful lot of money but you would need to be paying premiums for almost 46 years before the insurance company was winning on the deal.

The big issue is affordability. If you stop paying the premiums, the cover dies and you’re back to square one. That’s a big consideration when you look at the size of the premiums and the fact that older people tend to have dramatically reduced income.

And remember, even after the first person dies, the surviving member of the couple needs to keep paying those premiums or the whole arrangement falls. Can they afford that?

Of course, the children – and it will most likely be for the couple’s children that they would consider such an expense – will benefit and they can use the small gift allowance to help meet the cost of premiums if they have the resources. But it is still a big ask.

If it is something you want to consider – and that's most unlikely on an estate like yours – there are, I gather, only three insurance companies in Ireland that deal with these policies. They are: Royal London, Zurich and Irish Life.

The other limiting factor is age. You must be at least 18 to take out a policy but, more relevant for most of us, you need to do so before you turn 75.

With two children, they are entitled to inherit €670,000 between them . . . just €30,000 shy of your home’s value. As of now, they would face a bill of €5,000 each, which should not require such a policy.

[ dcoyle@irishtimes.com ]