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Mortgage Protection for Cohabiting Couples

 

Today in Ireland, an increasing number of couples are taking the ‘cohabiting’ route, choosing to either postpone marriage or to not enter it at all. According to the Law Society, a 2016 consensus showed that of the 1.22 million families living in Ireland, over 152,000 couples are cohabiting, and that figure is up 6% since 2011. Of that number 75,587 reported cohabiting couples in Ireland are living with children nationwide – an increase of nearly 24% up since 2011.

 

Who qualifies as a Cohabitant?

 

Cohabitants are regarded as two adults who have already lived together in a long-term intimate or committed relationship and splitting expenses, for two years where there are children in the relationship, and five years where there are no children involved. Non-traditional families were previously not provided with any legal status and so do not have the same legal rights as married couples as are provided under the ‘Marriage Act 2015’.

 

Enter the Civil Partnership and Certain Rights and Obligations of Cohabitants Act 2010 that has celebrated a milestone for cohabiting couples. This Act provides cohabitants with extensive information on further entitlements, such as maintenance, property, and inheritance rights. However, cohabitants still need to consider the important implications that arise on death of a partner (succession), and Tax liability.

 

Implications on death of a partner

 

Married couples or those in a Civil Partnership are governed by the Succession Act of 1965, allowing the surviving spouse a legal right to a share in each other’s estate. If you are in a Cohabiting relationship, without a valid will you would have no automatic right to any share in assets or the estate of your partner on their passing.

 

Since the Redress scheme for Cohabiting Couples was introduced, surviving cohabitants can be make an application to the court for the provision of the estate of the deceased partner (here, a court order is exempt from inheritance tax).

 

Inheritance Tax

 

In the case where a married or civil partner inherits from the surviving partner, there would be no inheritance tax considered. On the other hand, and for the purposes of Capital Acquisition Tax (CAT), cohabiting couples would have to pay inheritance tax as they would be seen as ‘strangers’ in the eyes of Revenue.

 

On receiving a gift or inheritance surviving partners are provided with the Inheritance Tax threshold of up to €16,250, however, generally given size of the gift or inheritance value such as property, this could result in an particularly unfortunate Tax bill, as anything in excess of this threshold would be taxable at a rate of 33%.

 

 

Protecting against Inheritance Tax

 

For cohabitants additional Life insurance is the smartest way to reduce Inheritance tax. Many cohabiting couples that have Mortgage Protection in place may not fully understand how Revenue will treat the inheritance of the property of the surviving partner. If structured correctly, taking out a life insurance policy on a ‘Life of Another basis’ will help to remove any unexpected tax concerns. There are various conditions that must be in place such as who paid the premiums on the policy, who owned the property, and how the policy was set up. 

 

This process is assisted by a Single Life Mortgage Protection where both parties will take out two Single Life, and a Life of Another basis Insurance Policy on each other’s lives, and each partner must pay for the premiums on the each other’s policy (and visa versa) which runs for the same length of time as the mortgage.

 

Switching Mortgage Protection Cover

 

Let’s look at the below example that illustrates a cohabiting couple:
 

Sarah and Alan are cohabiting together and buy a house in their joint names valued at €400,000.
Each contributed to paying for the deposit of €50,000.
 

They take out a Dual Protection policy for €350,000 to pay off the mortgage, should one of them pass away. Both Alan and Sarah are working and the mortgage protection premiums are paid from a joint bank account.
 

In the first year Alan dies and the mortgage protection policy clears the mortgage:
 
o Sarah already owns 50% of the property, so she will inherit Alan’s half of the property.

– 50% X €400,000 = €200,000 (since its dual life, she will pay the total amount of the inherited value as she is benefitting from it).
 

o Sarah must therefore pay 33% of any inheritance over the threshold of €16,250.

– 33% X (€200,000 – €16,250) = €60,638. (Sarah’s Tax Liability).
 

As we can see, the mortgage protection policy has cleared the mortgage, however, since Sarah has technically inherited Alan’s half of the property she is now left with an unfortunate tax bill.
 

Here is where the Life of Another Solutions comes in handy:

 

1. Two Single Life Policies – Both earning an Income

 

Each partner sets up their own Single Life Mortgage Protection Policy, insuring each other’s life for the full mortgage amount of €350,000 (purchase price of the property less the deposit). This would be referred to as a “Life of Another” policy.
 

For the policy to be structured correctly, they would need to ensure that the premiums paid on each policy comes from each of their own bank accounts funded by their own earnings, and NOT a joint account. Therefore, referring back to the example above, should Alan’s premature death occur in the first year, the benefit paid out would belong to Sarah as she is the owner of the policy on his life and paid the premiums (this is very different to a joint policy) and would ensure that Sarah’s inheritance would be reduced in the event of Alan’s death (and visa versa).
 

So as we can see, Sarah would thereafter inherit the mortgaged portion of the house and be exempt from paying for Inheritance tax on that portion. However, she would still have to pay for the mortgage-free value that she inherits.
 

Mortgage free value:
 

o Sarah inherits the remaining 50% of the free value on the property.

– 50% X (€400,000 – €350,000) = €25,000.
 

o Sarah will have to pay 33% Inheritance tax on the amount inherited over €16,250.

– 33% (€25,000 – €16,250) = €2,887.50

 

When organizing two Single life Insurance, and “Life of Another” Mortgage Protection Policies paying for the premiums from their own separate accounts will make sure that potential tax liability will be significantly reduced.

 

2. Dual Life Cover increase – One partner earning

 

In cases where only one of the partners own the property, their situation would be slightly different.
 

Assuming Alan owns the property outright, and is the sole owner, he paid for the deposit, currently pays for the mortgage repayments and the premiums on their Mortgage Protection policy, there would be a potential Inheritance tax Liability if Alan should pass away.
 

In this case, we observe an alternative solution that would provide for Sarah should something happen to Alan. They could make an agreement with the lender to apply for the increase in the cover amount of their Dual Life Mortgage protection so there would be enough money left over to pay for the inheritance Tax bill.

 

Here is how this would work:

 
Instead of just taking out the €350,000 to clear the mortgage, Sarah and Alan increase the amount of cover on their policy by €189,012, bringing the total sum assured to €539,012. The additional cover of €189,012 would be enough to cover the cost of the inheritance tax based on the current tax rules and the value of their property; €350,000 + €189,012 = €539,012.

 
If in the first year Alan dies, the Mortgage Protection policy would pay out the proceeds of €539,012 to the Mortgage Lender. Sarah is legally entitled to the balance of the proceeds (€189,012) by the lender after the €350,000 has been cleared.

 

Thereafter, Sarah would inherit the property under the terms of Alan’s Will that was drafted up for the amount of €400,000. Since Alan paid all the premiums of the policy, the amount of €189,012 would also be considered an inheritance.

 
Sarah’s total Inheritance amount’s to: €400,000 + €189,012 = €589,012.

 
o Sarah will pay 33% Inheritance tax on the amount inherited over the threshold of €16,250.

– 33% (€589,012 – €16,250) = €189,012 (Sarah’s tax Liability).


Taking out the additional cover of €189,012 means that Sarah would have enough to cover the Inheritance Tax Liability on inheriting both the value of Alan’s property and the balance of the Mortgage protection policy proceeds.

 

Other ways to reduce one’s Inheritance tax Liability:

 

Section 72 Life Assurance policy

 

This is a very useful and widely available Revenue approved whole-life Insurance policy product that is specifically designed to deal with inheritance tax, for example, when parents bequeath property to their children. It works similarly to regular Life insurance where you would pay the premium on your policy, and on death, in return, your beneficiaries would receive a tax-free Lumpsum to cover the tax bill. Revenue will not charge Capital Acquisitions Tax (CAT) on the proceeds if the money is set to pay for the Inheritance Tax itself.

 
To qualify for Section 72 cover, the below are just a few of the main qualifying criteria:

 
– The person who owns the plan must pay the premiums.

– A joint-life plan can only be taken out by a married couple or registered civil partners.

– The plan holder must continue to pay the premiums of the policy for at least eight years.


Small Gift Exemption

 

This comes in very handy if one party is not earning an income and can’t afford to pay for the cost of the insurance premiums themselves. One could consider benefiting from the annual Gift Exemption which is currently €3,000.

 

As an illustration, we can apply this exemption in the first case study Single Life, Life of Another mentioned above; If Alan did not have enough funds to pay for the premiums on the Insurance policy, he could then receive a gift tax free of up to €3,000 annually from Sarah, and use the money to pay the insurance premiums on his policy.


Dwelling house Exemption

 

There are ways that one could inherit a house without actually having to pay any inheritance tax (or Capital Acquisitions Tax). The Dwelling house Exemption in circumstances where couples are cohabiting could be deemed very useful. There are, however, conditions to qualify for this exemption as set out by the Finance Act of 2016. In order to qualify, and be exempt from Inheritance Tax completely, the following must be met:

 
1. The house was the only or main home of the person who died (this condition does not apply if you are a dependent relative).

2. You lived in the house for three years before the person’s death.

3. You do not own, have an interest or a share in any other house, including one you acquired as part of the same inheritance.

4. The house continues to be your main or only home for six years after the date of inheritance. This does not apply if you are over the age of 65.

 

In Summary

 

There are many strategies one can consider in reducing potential Inheritance Tax, however not all cohabitants financial circumstances are the same. It is importance to seek advice from a Qualified Financial Advisor who will assess your current circumstances, and help put together suitable solution tailored to your specific needs, thereby helping you make an informed decision and giving you peace of mind.

 

 

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One thought on “Mortgage Protection for Cohabiting Couples

  1. Hello,
    I want to take out mortgage protection insurance on a life of another basis, how do I go about doing so?
    Kind Regards,
    Amanda.

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