Minimise the financial consequences of inheritance tax for your family

A common issue for individuals who receive an inheritance is how to fund the Capital Acquisitions Tax (CAT) on it.

Depending on the relevant valuation date, the CAT may be payable within a very limited timeframe. The tax year for CAT purposes runs from 1st September to 31st August the following year. If the valuation date is before 31st August in any year, the CAT will be payable by 31st October of that year.  

This issue can be particularly acute where someone inherits an illiquid asset such property, or shares in a private company (where CAT reliefs are not available). To avoid incurring interest and penalties, assets may need to be sold at inopportune times or beneficiaries may have to source funds through bank lending, if they do not have sufficient liquidity within their own asset portfolio to meet CAT obligations.  

How can a Section 72 policy be useful?

A Section 72 policy can provide a solution to the problems outlined above. Unlike the proceeds of other life insurance policies, which are regarded as taxable assets and therefore fully subject to CAT, the proceeds of a Section 72 policy are exempt from CAT, when the proceeds are used to pay the beneficiaries’ CAT liabilities.  

The proceeds of the policy can also be used to pay the tax liability arising from the inheritance of an Approved Retirement Fund (ARF). 

How does a Section 72 policy work?

Policies are set up on a ‘whole of life’ basis, unlike normal life insurance policies which finish at a predetermined age e.g. 70 or 75. Section 72 policies remain active for the lifetime of the policy holder, and upon their death will generate a lump sum, provided the premiums have been paid.   

For married couples, most Section 72 policies are set up on a ‘joint life, second death’ basis. This means that the amount under the policy will only become payable on the death of the second spouse. This type of policy is useful in cases where the entire estate will pass from one spouse to the surviving spouse, as CAT will typically only become an issue when the second spouse dies, at which point the remaining assets will pass to their children. A “joint life, second death” policy will usually be less expensive than a single-life policy. 

The annual premiums are fixed at the outset (upon completion of medical underwriting) and cannot be increased by the Life Office which underwrites the policy. Because of this, it is possible to project the period of time over which total annual premiums paid equate to the sum assured. The point at which the premiums paid equate to the sum assured refers to the break-even point.   

The table below is for €1m of cover, and is for illustrative purposes only. Pricing is indicative only and is not guaranteed.  
 

Source: Clearchoice, October 2024. 

Section 72 policy premiums 

The annual premiums must be paid for the life of the policy holder, otherwise the policy will lapse without value. Therefore, it is important to consider affordability of the premium in the context of your overall financial plan and assess the impact of paying the premium on the value of your estate. 

What else should be considered when deciding on the level of cover? 

• How much CAT the beneficiary might have to pay based on current CAT thresholds and CAT rate exposure. 
• The liquidity of the inheritance.  
• Any CAT relief (e.g. dwelling house relief on the inheritance of the family home or business property relief on the inheritance of a family business) that may be available to your beneficiaries which would reduce their CAT exposure on the inheritance.  
• Any foreign tax, e.g. US FET that may be due on an inheritance as the foreign tax due may reduce the amount of CAT payable. 
• The interaction between a Section 72 policy and any assets placed in a discretionary trust on your death would need to be considered. 

To find out more about how we can help you put in place a tax-efficient estate plan, contact your Adviser. If you’re new to Davy, why not request a call?