Inheritance Tax and Mortgage Protection
Did you know that generally only married couples and registered civil partners are exempt from inheritance tax? This means, if you or your partner should pass away and you are not married, or in a registered civil partnership, you may have to pay inheritance tax, even if you jointly own your home.
According to the 2016 census, there are over 152,000 cohabiting couples living in Ireland. As you know, even though a cohabiting couple live together, may own a property together and possibly have children together, in the eyes of Revenue they are treated as ‘strangers’ when it comes to inheritance tax.
With a current inheritance tax threshold of €16,250 for cohabiting couples, this can result in an unexpected and unwelcome tax bill for the surviving partner, should the worst happen.
While many cohabiting couples put mortgage protection in place to ensure the mortgage is cleared upon the death of a partner, what they may not fully understand is how Revenue will treat the inheritance of the property by the surviving partner.
Who owned the property?
How the mortgage protection policy was set up?
Who paid the premiums, are some of the factors that can affect how much inheritance tax the surviving partner must pay.
Couples who live together and are not married or in a registered civil partnership, are often referred to as cohabiting couples.
When it comes to inheritance tax, cohabiting couples pay tax of 33% on an inheritance above the current threshold of €16,250
Here’s how it works;
Sue and John are an unmarried couple and buy a house in joint names valued at €400,000. They both paid towards the €50,000 deposit and will jointly pay the mortgage. They take out Dual Life Mortgage Protection for €350,000 to pay off the mortgage if one of them passes away. In the first year John dies and the Mortgage Protection policy clears the mortgage:
• Sue already owns 50% of the property, so she inherits John’s 50% of the property value. 50% x €400,000 = €200,000
• Sue must pay 33% inheritance tax on the amount she inherits above the threshold of €16,250. 33% x (€200,000 – €16,250) = €60,638 (Sue’s tax liability)
Dwelling House Exemption
It may be possible to inherit the family home from your cohabiting partner without paying inheritance tax, if you qualify for what’s called the Dwelling House Exemption.
According to the Finance Act 2016, you qualify for the Dwelling House Exemption and will not have to pay inheritance tax on a house if:
• The house was the only or main home of the person who died (this condition does not apply if you are a dependent relative).
• You lived in the house as your main home for the three years before the person’s death.
• You do not own, have an interest or a share in any other house, including one you acquired as part of the same inheritance.
• The house is your main home for six years after you receive the inheritance. This does not apply if you are over 65.
If you are a cohabiting couple and the Dwelling House Exemption does not apply to you, it is possible to structure your Mortgage Protection in a way that would help to fund, and in some circumstances may even reduce, your inheritance tax liability.
Your options will depend on whether you are setting up Mortgage Protection cover for the first time or whether it is already in place.
How Sue and John could fund for their potential inheritance tax liability when first setting up their Mortgage Protection policy
Example 1 – Both partners earning
Set up two Single Life policies rather than arranging one Dual Life Mortgage Protection policy.
John and Sue could each set up their own Single Life Mortgage Protection policy, insuring each other’s life for the full mortgage amount (of €350,000).
This amount, as we have already seen, is the purchase price of the property of €400,000 less the deposit that they have paid of €50,000.
This is known as a Single Life-Life of Another policy. If they do it this way, they would also need to ensure they pay the premium on the policy they own from a sole bank account funded by their own earnings, not a joint account (so the key issue is whether they are both earning and therefore able to fund their own policy).
Doing it this way means Sue’s inheritance would actually be reduced in the event of John’s death, and vice versa. If John dies in the first year, it is the proceeds from Sue’s policy that will clear the mortgage. Sue will effectively inherit the mortgaged portion of the house from herself and therefore be exempt from paying inheritance tax on that portion.
Sue would still have to pay tax on the mortgage free value that she inherits:
• Sue inherits 50% of the remaining, mortgage free value of the property.
50% x (€400,000-€350,000) = €25,000
• Sue pays 33% inheritance tax on the amount she inherits above the threshold of €16,250. 33% x (€25,000 – €16,250) = €2,887.50 – Sue’s tax liability
Arranging two Single Life-Life of Another, Mortgage Protection policies and paying the premiums from their own funds means, in this example, Sue’s inheritance tax liability would be significantly reduced as Sue is the beneficiary and paid the premiums on the policy that paid out.
Example 2 – One partner earning
Increase the amount of Dual Life Cover if, however, only one of the two partners owned the property, the situation would be different.
Let’s assume that Sue owns the property on her own. Sue paid the deposit and as the sole earner, she pays the mortgage repayments and the premiums on their Mortgage Protection policy. They are mindful of the potential inheritance tax liability that would occur for John if Sue died.
So they opt, with the agreement of their lender, to increase the amount of cover when they apply for their Dual Life Mortgage Protection, so there would be enough left over to pay towards the likely inheritance tax bill. Instead of taking out just €350,000 cover to clear the mortgage, Sue and John increase the amount of cover on their policy by €189,012, bringing the total sum assured to €539,012. This additional cover, when paid out, would be enough to cover the cost of inheritance tax based on the current tax rules and value of their property.
Details of how this amount is calculated are set out below.
€350,000 + €189,012 = €539,012
• In the first year Sue dies and the Mortgage Protection policy pays out €539,012 to the lender, as the policy was assigned.
John is legally entitled to the balance of the policy proceeds after the mortgage debt of €350,000 has been cleared and receives €189,012 from the lender.
• John inherits the property under the terms of Sue’s will, which is worth €400,000. The balance of the Mortgage Protection policy proceeds of €189,012 is also regarded as an inheritance from Sue as she paid all the premiums.
• Therefore, John’s total inheritance amounts to €589,012.
€400,000 + €189,012 = €589,012
• John must pay 33% inheritance tax on the amount he inherits above the threshold of €16,250.
33% x (€589,012- €16,250) = €189,012
John’s tax liability
Taking out the extra cover of €189,012 means John has enough to cover the inheritance tax liability on inheriting both the property and the balance of the Mortgage Protection policy proceeds seen in this example. If you need more information; Call Frank on 087 2557 448 or email Info@Frankryanfinancialservices and you can also Contact him through our website here.