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Monday 26 September 2016

Your Questions: I'm going through a messy divorce - but what should I do about our life insurance cover?

Darragh Feely

Published 19/07/2015 | 02:30

Divorce is a technical and complicated area, so your first step should be to talk to your solicitor, of course, and also a financial broker for advice on your personal circumstances
Divorce is a technical and complicated area, so your first step should be to talk to your solicitor, of course, and also a financial broker for advice on your personal circumstances

I am going through a rather acrimonious divorce and I'm trying to collect as much info as I can as to my financial standing before I meet my husband in court.

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I've tied up a lot of loose ends involving pensions and an investment property, but I'm looking at a life insurance policy my husband and I have and I'm wondering what steps I need to take? Will I need to amend an existing policy or take out a new one? Are there tax implementations if I don't?

Margaret, Rathmines, Dublin 6

This is a technical and complicated area, so your first step should be to talk to your solicitor, of course, and also a financial broker for advice on your personal circumstances.

But generally speaking, in this type of scenario a person could apply to the courts for a Financial Compensation Order (FCO). This requires a spouse to put in place or to maintain in place an insurance policy in favour of the other spouse.

For example, Sean and Mary are getting divorced. Mary seeks a FCO to compel Sean to effect €200,000 life cover for her and their children's benefit. The policy is written under trust for the benefit of Mary. If Sean then dies, Mary would receive the life policy proceeds of €200,000 tax-free, as there is an FCO in place.

It's important to note that, if Mary remarries, the FCO lapses.

What happens if there is no FCO in place?

If Sean already has the life cover and agreed to keep it going for Mary and their children after their divorce without Mary seeking an FCO then, if Sean died, the €200,000 policy proceeds would not be exempt from capital acquisitions tax (CAT).

In this scenario Mary is viewed as a 'stranger' under tax law and the tax exempt threshold is only €15,075. Inheritances over this amount are subject to tax at 33pc. Mary would then have to pay €61,025 inheritance tax on the policy proceeds.

I have been with my partner for over eight years - both of us having separated from our respective spouses some years before that. We have decided now that we are only just ready to relinquish some of our independence and move in together.

She is going to live with me in a house I'm paying a mortgage on - though she will now contribute also. However, a friend told me I should look at the mortgage protection policy I have on my home so as to take into account my new situation. What do I need to know?

Peadar, Mullingar, Co Westmeath

Yes, your friend is correct. There are very different inheritance tax rules for married couples/civil partners and for those that are co-habiting partners.

Married couples and civil partners who inherit following the death of one partner will not have to pay any inheritance tax no matter how much they inherit. However, cohabiting couples will be liable for inheritance tax. That's because you will be treated as 'strangers' under tax law, and more to the point, the tax exempt threshold is only €15,075. Inheritances over this amount are subject to tax at 33pc. It may not seem fair or equitable, but it's the law.

So that's the tax law, but how will this work based on your situation?

As an example, let's say the deceased partner paid for the mortgage protection cover of €400,000 solely themselves from their own bank account.

You, as the surviving co-habiting partner and based on the terms of the will, received the value of the €400,000 policy. You could now be liable for inheritance tax of a whopping €127,025.25 (€400,000 - €15,075 (the tax exempt threshold amount) = €384,925 x 33pc (the current inheritance tax rate) = €127,025.25).

Even if you have equally paid 50/50 for the mortgage protection policy between you from your joint account, as the surviving partner of a cohabiting couple, if you are paid the policy proceeds of €400,000, you could still be liable for a tax bill of over €61,000 (€400,000/2 = €200,000 - €15,075 = €184,925 x 33pc = €61,025.25).

There is a simple and legitimate solution to this potential tax liability, whereby each partner pays for the other partner's mortgage protection policy from their own bank account and income.

This is known as 'life of another' in industry terms.

In this scenario, where one partner has paid the other's premiums (and vice versa) and if the other partner died, there would be no tax liability as it would be deemed that the surviving partner paid for the benefits and therefore is entitled to the proceeds.

Your local financial broker will be able to give you personal and independent advice on any aspects of these issues.

A friend of mine was sick for a long period of time and aside from the horribleness of the illness she had to contend with a very stressful financial situation, as she couldn't work for a long time.

So I'm thinking of taking out some form of income protection - but it seems very expensive and also I'm not sure if it's exactly what I need.

Brenda, Trim, Co Meath

If you work in the private sector, your employer might have sick leave benefits that will automatically cover you when you're off sick. But these are usually only paid out up to a certain time limit, often only for six months on full pay. It often stops completely after 12 months.

It's not something many people are very aware of, we often find.

Once your employer sick pay ends, you would have to rely on the State Illness Benefit, currently just €188 per week for eligible employees, and any savings and investments you might have. That's a level of income many people would struggle to now survive on and still pay their outgoings that will be still there despite being sick: the mortgage, school costs or fees and so on.

And don't forget: there is no State Illness Benefit available to self-employed workers.

Income protection cover will provide you with a regular income if you cannot work due to illness or injury. It can help protect your lifestyle by limiting the financial consequences of suffering an illness or injury which prevents you from working. Payments continue either until you are well enough to return to work or your policy ends.

With a typical policy you can cover up to 75pc of your earnings, less any State Illness Benefit entitlement, up to a maximum of €250,000 per annum.

A 30-year-old with a need for a replacement income of €50,000 per annum, could put income protection cover in place for a little as €37 per month. (There are terms and conditions with this type of cover, but a broker will be able to explain them to you.)

And under current tax law (November 2014) the premiums you pay may also be eligible for tax relief. This can reduce the cost of your cover by up to 40pc if you pay income tax at the higher rate.

 

Email your questions to jcradden@independent.ie or write to 'Your Questions, The Sunday Independent Business Section, 27-32 Talbot Street, Dublin 1'.

While we will endeavour to place your questions with the most appropriate expert to answer your query, this column is a reader service and is not intended to replace professional advice.

Darragh Feely is broker sales manager at Royal London

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