Estate planning is the transferring of assets to family, friends and charity tax efficiently. It covers gifting while alive and inheritance on death. Estate planning is most pertinent in our minds when we have accumulated a sufficient level of wealth, usually beyond what we can spend in our lifetimes. We shift our focus towards the legacy we wish to leave behind. What is our exit strategy? Once we have accumulated wealth and are financially independent, we can proceed to ask ourselves how much of our wealth do we plan on spending each year over the course of our lifetime. It is important to secure our financial future first, factoring in all potential costs as we age. Overestimating travel, transportation, hobbies, medical, independent living, elder care and nursing home costs. If we estimate how much our ideal lifestyle will cost and all the other likely costs into old age and still have surplus wealth, we have two options. We can spend more and/or gift the difference. We need to weigh up the benefit of spending more or gifting to determine which will have a greater impact on our lives.
Giving has been shown to lift our happiness more than spending it on ourselves. It promotes good health, cooperation, social connection and gratitude. There is an old cliché that states money can’t buy happiness. Each of us will have a different definition of happiness but I believe a certain level of wealth provides security and relative peace of mind. Life becomes less arduous without the stress, anxiety and fear of week to week, month to month money problems related to basic needs. Basic needs will vary person to person depending on the lifestyle we are accustomed to. When we have achieved a level of wealth which secures our basic needs, we tend to have a baseline level of contentment too. These basic needs are psychological and safety needs such as food, water, warmth, rest, security and safety. Beyond this baseline level of wealth and contentment, an increase in our wealth does not necessarily equate to an equivalent increase in our happiness. Once our basic needs are met, psychological and self-fulfillment needs follow. Belonging, self-esteem and fulfilling one’s potential are the next steps. For many of us achieving that baseline level of wealth and contentment will take decades. Being in a position to gift allows us to help others along this journey.
The ideal scenario is to have spent or gifted our last euro on our last day. How we gift will depend on the value and liquidity of the assets in question. Liquidity refers to how quickly we can access assets. A deposit account is a liquid asset as we can access it instantly. A property is an illiquid asset as it will take time to be sold to access its value. If we choose to gift some of our wealth it is preferable to do so with a warm hand rather than a cold hand. I say this because it is more rewarding to see the impact of our gifting during our lives. Not to mention reducing our potential Capital Acquisitions Tax liability. Money can also be a very contentious issue within families and the finality of death can leave many unanswered questions. Who receives what and why can fracture relationships. Planning, transparency and communicating our wishes when alive can avoid undesirable outcomes when we are gone.
It is no secret that Irish people are a very giving group. Giving of our time, energy, skills and resources, both financial and non-financial. Whether that’s helping out our families, friends, colleagues, a cause near and dear to our hearts or strangers down on their luck, our ability to empathize with others is one of our biggest strengths. Giving is one of the most rewarding acts we can do. Adding to someone else’s life only adds to ours. We can give with the best intentions, however there are times when we can give to our own detriment. When it comes to estate planning, we need to secure our own future before looking after others. In my line of work saving for our children’s future is a high priority goal for many parents. It is only natural for parents to want to provide the best opportunities for their children. In episode 10 I referred to the airplane safety briefing. In the event of cabin pressure falling during a flight, oxygen masks automatically fall from overhead. We are then instructed to secure our own mask first before tending to others. This is because if we neglect to secure our own mask and tend to others first, we run the risk of falling unconscious and subsequently become a liability to others. If we tend to our children’s financial future before our own, we run the risk of becoming part of a sandwich generation. The term sandwich generation was coined for folks who are supporting growing children and ageing parents. Of course, this can result for a variety of reasons unrelated to money. However, if parents prioritize their children’s financial future before securing their own, they might require financial support of their children at a future date. We don’t want our children to become sandwiched between supporting us and raising their own children.
Whether it is gifting or inheritance, it always helps to be organized. Death is not a topic most people like to think about too much for obvious reasons. Regardless of our indifference to death, it is a certainty. Being financially organized prior to death will help minimize additional stress on those grieving. In episode 4 we discussed financial organization. Keeping our financial house in order will make life easier and it is no different when it comes to estate planning. Having a file for when we die which details all the financial information our loved ones would need is a great place to start. It should contain our Will, funeral instructions, insurance policies, bank accounts, direct debits, standing orders, pensions, investments, properties and so on. We will need to review this file annually. When it comes to estate planning it is always a good idea to consult a competent legal professional. A Will is a legal document that instructs how our estates assets will be distributed on death. If a Will is not explicitly executed, it can be challenged which may cause distress to those left behind. Probate is the process of certifying that a Will is valid and all legal, financial and tax affairs are in order. Depending on the complexity of the estate, probate can take anywhere from 3 to 6 months to complete. If there is no Will in place the state will distribute the assets in accordance with the laws of intestacy. An enduring power of attorney is a legal mechanism which allows a specially appointed person to make decisions on our behalf should we become incapacitated. If an enduring power of attorney is not in place and we become incapacitated through illness, disability or degenerative disease our assets may become frozen unless they are in a joint account. This is where the ownership structure of financial accounts can cause financial friction between spouses. Access to an individual account is usually restricted until the probate process is complete. If married or in a civil partnership our assets will go to our surviving spouse or civil partner free of Capital Gains Tax and Capital Acquisitions Tax on death. On death of a spouse, we should apply to the Revenue Commissioners for a letter of clearance.
Having worked hard our entire lives, paid our taxes and accumulated wealth it is a wonderful position to be in. We have established our spending needs and wants across the go-go years, 65-75, slow-go years, 75-85, and no-go years, 85-95. We are now considering gifting some of our surplus wealth. Giving usually starts at home. Gifting surplus assets to our family may incur Capital Acquisitions Tax (CAT). Capital Acquisitions Tax is charged to beneficiaries of assets gifted or inherited such as property, investments, pensions, cash and so on, above certain tax-free lifetime limits. CAT is effectively a double tax as most of the wealth we will have accumulated throughout our lives has already been taxed. Capital acquisitions tax is currently 33%. There are three CAT groups – Group A - Son or Daughter with a tax-free lifetime limit of €335,000, Group B - Brother/Sister/Niece/Nephew/Grandparent/Grandchild with a tax-free lifetime limit of €32,500 and Group C - anyone not included in Group A or B with a tax-free lifetime limit of €16,250. Any gift or inheritance valued above the applicable tax-free lifetime limit is liable to CAT at 33%. For example, Sophie is fortunate enough to receive a gift of €250,000 from Sophie’s parents, Linda and Peter, five years ago and subsequently receives another €250,000 five years later. Sophie falls under group A as she is the daughter of Linda and Peter. Therefore, Sophie can receive up to €335,000 tax free from Linda and Peter before being charged CAT. In total Sophie received €500,000. We subtract Sophie’s €335,000 tax free lifetime limit and the €3,000 annual small gift exemption which leaves us with a balance of €162,000 taxed at 33% CAT. The total CAT tax bill is €53,460.
There are tools at our disposal to help minimize the amount of CAT. The small gift exemption is one such tool which allows each of us to gift up to €3,000 tax free to anyone in a calendar year. Using Linda, Sophie and Peter’s example above. Sophie is married to David and they have three children. Linda and Peter have accumulated wealth beyond what they will need for the rest of their days. They wish to gift some of their wealth to help Sophie and David with an extension and renovation of their new home and start an education fund for their three grandchildren. Linda and Peter decide to make full use of the small gift exemption and gift €6,000 to Sophie, David and the three children for a total gift of €30,000. That is €3,000 from Linda and €3,000 from Peter for a total of €6,000, to Sophie, David and the three children. It doesn’t matter if it comes from or into joint accounts, it is €3,000 from any person to another person in a calendar year. Just be sure to record it as a gift when transferring the funds to their bank account. Linda & Peter decide to do this over four calendar years for a total gift of €120,000. The small gift exemption does not impact our tax-free lifetime limits under CAT. It may seem like a small sum, but it adds up on a per person basis over many years. It can be a useful tool before, during and after we breach the Capital Acquisition Tax lifetime thresholds so long as we have the money, people and time. It is also important to factor in spousal relationship dynamics when gifting.
A Section 73 savings plan is specifically designed to reduce gift tax that arises on the transfer of assets to a beneficiary. If we plan on gifting an asset in eight or more years’ time, we can estimate the amount of CAT liability that will be owed by the beneficiary. The person gifting the asset may not wish to burden the beneficiary with CAT at 33%. As a result, they will setup a section 73 savings plan, making regular contributions over a minimum of eight years. Once the eight years have passed the proceeds can be gifted to the beneficiary exempt of CAT. The beneficiary must then use the proceeds received to pay CAT on the gift from which the CAT liability arose within 12 months. For example, Linda and Peter want to gift a property to Sophie and David with a value of €500,000. When we subtract the group a CAT threshold of €335,000 and small gift exemption of €3,000 and assuming no previous gifts have been made, we have a balance of €162,000. This is liable to CAT at 33% which equals €53,460. If Linda and Peter plan ahead of time and have the financial resources, they can pay some or all of this CAT liability by setting up a Section 73 policy. If they were to pay the full CAT liability after 8 years, the monthly savings plan premium required would be €557 per month for eight years. This savings plan is especially useful when seeking to gift a property without the beneficiary having to pay the CAT liability out of pocket, take out a loan or liquidate the property to pay the CAT liability. If the savings plan are not used to pay for CAT it reverts to a regular savings policy.
Section 72 is a whole of life insurance policy that is designed to settle our children’s inheritance tax bill on our death. We pay regular policy premiums for the relevant level of CAT liability cover. This is the amount or value above our lifetime tax free CAT limit mentioned previously. Upon death the policy pays out a tax-free lump sum to the beneficiary which they’ll use to clear the inheritance tax liability that is created from the inheritance of estate assets.
A trust is a private legal relationship created for the management of assets on behalf of another person. The settlor places assets in a trust. The trustee holds the legal title for the benefit of the named beneficiaries. There are a variety of trusts available depending on our circumstances. Trusts are usually established with the intention of future proofing assets from creditors, relationship claims, securing the future financial needs of a child or person who cannot look after themselves, succession planning for the family business and estate planning as assets within a trust do not form part of a person’s estate upon his or her death. Trusts are a specialist area and should only be considered if absolutely necessary. For the majority of us, trusts will not be required.
Depending on the proportion of our net worth locked up in our home, downsizing may be an option. Assuming we are debt free, downsizing can release equity within the home. There is no Capital Gains Tax on our principal primary residence. Say we have a net worth of €2,000,000 of which €1,500,000 is the value of the family home. Our home is effectively 75% of our net worth which is locked up in our home. Depending on our attachment to our home we may explore downsizing to a home that costs €750,000. This results in an equity release of €750,000 we can then use to help fund our retirement. It also reduces the future CAT liability for the children on inheritance.
There are a number of tax reliefs and exemptions relating to Capital Acquisitions Tax (CAT) and Capital Gains Tax (CGT) we can avail of depending on our circumstances. Dwelling house relief is where a person is gifted or inherits a home exempt of CAT so long as certain conditions are met. This can be another useful tool in reducing our potential CAT liability. Business relief reduces the taxable value of a business gifted or inherited by up to 90% for CAT purposes so long as certain conditions are met. Agriculture relief is similar to business relief where the value of agricultural property can be reduced by up to 90% for CAT purposes when it is passed to a farmer so long as certain conditions are met. Favorite Niece or Nephew relief allows for Group A tax free lifetime limit under CAT of €335,000 when being gifted or inheriting a business as a niece or nephew so long as certain conditions are met. Entrepreneur relief reduces the CGT rate from 33% to 10% on disposal or part disposal of qualifying business assets up to €1,000,000. Retirement relief reduces or removes CGT when disposing of a business or farm. If disposing of a business to a child and are aged between 55 & 65 we can claim full relief on the value of the business. If we are 66 years of age and above the relief is restricted to €3,000,000. If disposing of a business to persons outside the family, we can receive relief up to €750,000 between 55 to 65 years of age and €500,000 from 66 years of age onwards. It is important to remember that in certain scenarios we are also able to offset allowable losses on chargeable gains for CGT purposes so long as they occur in the same tax year. Surplus losses can be carried forward to set against future gains.
In summary, secure our financial future by estimating the cost of our lifestyles to the end of our days. A good financial planner can assist with this. Having a good understanding of what our spending will look like we can reconcile this with our projected wealth on our last day. The difference between what we plan on spending and our surplus wealth can mean we spend more on experiences and/or gift the difference. If we do give, give carefully and intentionally. How we gift can vary depending on our relationship with the recipient. A gift or inheritance often amplifies the money values a person already has, good or bad. A large sum of money can be as much a curse as a blessing. Be legally and financially organized. If possible, give with a warm hand rather than a cold one. Make full use of the estate planning tools at our disposal. Giving is not all about money, our time, expertise and skills can be worth more to others than money. If we are hesitant to give, start small. Depending on our means and circumstances explore trusts and family partnerships if beneficial. Seek good advice from a financial planner, legal professional and tax advisor.
The Revenue and citizens information websites can be a useful resource when it comes to estate planning. The Society of Trustees and Estate Planning (STEP) are a group of professionals who specialize in estate planning.
This week’s book recommendations are Happy Money: The Science of Smarter Spending by Elizabeth Dunn and Michael Norton. Two professors explain how money can buy happiness when we follow five core principles of smart spending. And Factfulness: Ten Reasons We’re Wrong About the World – and Why Things Are Better Than You Think by Hans, Ola and Anna Rosling. Hans Rosling was a physician, academic and public speaker. Some of us may have seen his presentations on Ted Talks. Hans passed away in 2017 after a battling pancreatic cancer. Factfulness was published posthumously and it details how the world is in a much better state than we might think.
This week’s movie recommendations are Interstellar, Earth’s ability to support human life is slowly wilting. A pilot and father played by Matthew McConaughey leaves his family and Earth in search of an alternative planet to save the human race. Also starring Anne Hathaway and Jessica Chastain. And A Beautiful Mind: Russel Crowe plays a brilliant mathematician who has the world at his feet when his life descends into paranoia, fear and disorder.
Link to Spotify podcast episode: https://open.spotify.com/episode/0c8Ax5dKjpZCON1IuwtkJA?si=98ce33b0db0040f7
Link to Apple podcast episode: https://podcasts.apple.com/ie/podcast/s1-e11-estate-planning/id1539630506?i=1000506679997
For personal financial planning advice email firstname.lastname@example.org or call (01) 539 2670.