Co-Habiting Couples & Mortgage Protection … Tread carefully as there is a tax landmine ..
Marriage is not everyone’s cup of tea but certainly, it can be a very tax-effective route to go given the way Revenue look on cohabiting couples. In terms of what defines co-habiting … to quote the Citizens Information website ..’ If you are living with another adult and in an intimate and committed relationship with them, but you are not married or in a civil partnership, then you are cohabiting.’
Unfortunately, cohabiting couples are treated very differently to married couples in terms not only of their legal rights but also in terms of taxation. This is particularly relevant on the mortgage protection side as Revenue assess cohabiting couples as individuals. This has important ramifications when it comes to the way mortgage protection cover is set up for cohabiting couples.
With over 152,000 couples in Ireland in the last Census it is a sizable audience so it is vital that where such couples go down the property acquisition route and take out a mortgage – they do it in the right way. If they don’t set up their mortgage protection cover correctly the spectre of a hefty inheritance tax bill looms large should one of the partners sadly pass away.
Worst case Scenario
Let’s look at the worst case scenario first where we assume the cohabiting couple set up their mortgage protection cover as they think is appropriate..
Joe and Kamala see a big white house that they like which is up for sale, valued at €300,000. They raise the €75,000 deposit and take out a mortgage of €225,000 for the balance to buy it. They also take out Dual Life Mortgage Protection cover for the loan amount over 25 years. In the first year, poor Joe passes away and the mortgage protection cover kicks in to clear the mortgage loan. If they were married that would be the end of it tax wise as Kamala would simply inherit the house with no tax liability.
However, as they were cohabiting Revenue now issue Kamal with a tax demand for €44,137*
*As Kamala owned 50% of the property she now inherits Joe’s 50% worth €150,000. With inheritance tax at 33% , she must pay this on any amount she inherits after her threshold allowance of €16,250.
€150,000 - €16,250 = €133,750 *33% = €44,137
Note: It may be possible to avoid Inheritance tax if one qualifies for the Dwelling House Exemption – always get independent tax advice.
Best case Scenario
Here Kamala and Joe got appropriate advice on the mortgage protection side (they must have gone to Low.ie!) and the policy was structured to reduce or negate any inheritance tax liability that might arise should one of them pass away.
Going back to our earlier example, this time Joe and Kamala each individually take out mortgage protection cover on each other’s life for the full mortgage loan amount i.e. €225,000. It is vital that the premiums for each policy are paid from each individual’s bank account and not any joint account. Thus, they have two single life, life of another mortgage protection policies so affordability is a key issue.
If Joe dies in Year 1, Kamala’ policy (i.e. it was Life of Another so Joe’s was the name on it) is triggered and the proceeds of her €225,000 mortgage protection policy are used to clear the loan on the house. Kamala now has inherited her own half of the house so she is exempt from having to pay inheritance tax on it but she has to pay it on the mortgage-free part ( i.e. the late Joe’s) that she inherited.
€300,000-€225,000 = €75,000 divided by 50% = €37,500 inheritance tax due.
However, taking her individual exemption threshold of €16,250 off this amount leaves her now with a net inheritance tax liability of €21,250*33% = €7,012
This is a considerable reduction on Kamala’s inheritance tax liability compared to our previous ‘worst case scenario’.
The key here is that by arranging the mortgage protection cover in this way and making sure Joe and Kamala paid the premiums from their own bank accounts; this has ensured a very reduced inheritance tax liability for Kamala as she is the beneficiary who paid the premiums on the policy that paid out.
In summary, it is very important for cohabiting couples taking out mortgage protection insurance to set up their policy or policies in the correct way as in the sad event of a death, the tax burden can be onerous at a very vulnerable time.