It’s a sign of the recovering economy perhaps, but as asset values rise, so too do people’s concerns about just how they can pass on their wealth tax efficiently to the next generation.
“The transformation of wealth in this country has been huge over the last four years,” notes Brian Walsh, director, financial planning, with Davy Stockbrokers.
Indeed latest figures from the Central Bank suggest that household net worth has risen 55.9 per cent since its lowest level of €430 billion in the second quarter of 2012.
This means that with tax-free thresholds still low compared to historical standards, many families will see “capital acquisitions tax (CAT) leakage” unless they prepare early and adequately for passing on their assets, be they investments, properties or family farms or businesses.
"Do engage and do discuss and do plan from an earlier age," says Andrew Fahy, head of tax and financial planning with Investec. "What's encouraging is that if you rewind 40 years people were very reluctant to talk about this kind of thing, they didn't want to involve the next generation. Now people are more open to it, as in order to get the right result they have to engage in dialogue. It's not vulgar to have an adult discussion about family wealth."
“I do think that everyone in this country should have a will, which allows these issues to be discussed, and stops assets going to the wrong people,” agrees Walsh.
Of course not talking about it can lead to conflicts and inefficiency from a tax perspective.
“It’s far better in my view to chat through these issues and tease them out, and not have surprises when a will is read,” advises Fahy.
After all, given the significant rise in house prices, many more people may face a tax bill.
“Even average families are going to come into a tax bill depending on the number of children,” adds Walsh. “People say, ‘I don’t mind paying 20 per cent – but 33 per cent seems a lot to be giving away, especially as I’ve paid income or CGT tax on it’.”
If families are happy to start moving their wealth earlier rather than later, the small-gifts exemption, which allows each parent to gift €3,000 to whomever they wish each year, is a “fantastic way of moving wealth within families”, Fahy notes.
Indeed it means that parents can gift their son, daughter-in-law, and three grandchildren €30,000 (5 x €6,000) a year tax free – and it won’t impact inheritance tax thresholds going forward. Over 10 years, this could mean €100,000 in tax savings.
“I’m not sure we’re using that quite enough in here in terms of children and grandchildren,” says Walsh, adding that it’s available on a “use it or lose it” basis – you can’t apply for it on a look-back basis.
Depending on the circumstances of the parents, other reliefs, such as CGT relief on passing on a business or a farm to a child, are still in play.
“But for non business owners, non farmers, it’s challenging with the threshold where it’s at,” says Fahy.
And even where there is a business, this can lead to further tensions.
“If there’s one business and there’s three kids, do you give it to the three or the one?” asks Walsh, adding that the business may not have the ability to fund a buyout of those other two. If this isn’t dealt with properly, the issue may end up in court and the business can be liquidated.
Where a business is earmarked for a particular child, Walsh suggests trying to encourage clients to set up pension schemes, or investment companies with a surplus of cash.
“Build up a number of pots that allow you to give assets that aren’t of a business nature to the other children.”
At Investec, they’re noting a growing interest in Section 72 life policies, which covers the cost of settling an inheritance tax bill in the event of your death.
“It can be quite effective at mitigating tax bills,” Fahy says.
The proceeds of the policy are not taxable, but they can be expensive.
Another asset that the coming generation increasingly has is an approved retirement fund (ARF). Unlike the annuities of yesterday, which died with one or both spouses, an ARF can be passed on, so it also needs to be considered in planning for inheritance.
Tax also comes into play depending on the type of investments you hold. As Fahy notes, if someone dies with a gain on shares, their CGT liability also dies – but the person who inherits the shares will be liable to CAT.
If, on the other hand, you want to shelter the person who invests from a tax bill, it may be better to opt for a funds style investment, liable to tax at 41 per cent. In this event, tax does arise on death, but the person inheriting it can use this as a credit on their CAT bill.
“It speaks to the importance of considering the tax efficiency of the portfolio,” Fahy says.
While trusts aren’t particularly popular in Ireland, family partnerships are. These can be useful for allowing assets to grow in the children’s name, while parents retain control and some income on that. CAT is limited to the original value of the assets, so any growth will be free of tax.
“It can be quite powerful, it provides growth in the name of the next generation and parents can still retain a degree of control,” says Fahy,
However while tax is undoubtedly important – it’s not everything.
“In my experience things done solely for tax reasons or overwhelmingly for tax reasons have a tendency not to end well,” Fahy says.
One of the challenges for parents of substantial means is supporting their children but not doing anything that would diminish their ambition to forge their own lives for themselves, while also not eating into the money they might need in their own retirement. This may mean that they’d rather not use the small-gift exemption.
“The biggest challenge is balancing that desire to help the next generation out with the need to provide for themselves,” says Fahy.
As Walsh notes, people who’ve built up wealth themselves often do not want their children to be given money that could hinder their ability to drive and educate themselves, and do well in business.
Another issue is when you might give certain children money during your lifetime, but not others.
If the balance goes to the children equally upon death, the situation can raise “big grudges”, notes Walsh.
In this case a reversionary clause can be added to the will, stating that the deceased leaves everything else to their children equally, and takes into consideration any gifts received during their lifetime.
Of course this requires the children to disclose any handouts they may have received, which can cause its own problems.
What might the Budget bring?
Inheritance has been in the budget spotlight of late. Last year, the Government raised the threshold that children can inherit tax-free from a parent to €310,000 and, given that the yield from the tax has increased, despite the rise in the ceiling, it’s expected that it might shorten the distance again this year, with a further increase on the cards.
“The intention is to get the threshold back up to €500k, close to the historical peak,” says Fahy, adding such a move will be welcome.
It may not come this October however.
“The Minister (for finance) indicated that he would give certainty to people over what’s going to happen over the next three years in the Budget, therefore any changes, like a change in the threshold going from €310k-€500k is likely to be phased over a three-year period,” Walsh adds.
But it’s important to note that while there is a loosening of inheritance tax on one side, there has been some tightening on the other. Last year’s Finance Act, for example, signalled the death knell to one scheme, the Dwelling House Relief, which was effectively used by many families to transfer a property free of CAT.
