Inheritance insurance: do's & don'ts

Succession planning is not only about transferring wealth, but also about the financial consequences for the survivors. Inheritance insurance can play an important role in this, provided it is set up correctly.

In this article, we clearly outline the main concerns, pitfalls and best practices so you can make informed choices.

What is inheritance insurance?

The problem: inheritance tax as liquidity risk

A death leaves deep marks, emotionally and financially. On what your dependents inherit from you, is inheritance tax owed. Depending on the size of your estate and the family relationship, that tax can add up to a significant amount.

This becomes especially problematic when your wealth is largely tied up in less liquid assets, such as real estate or enterprises. In that case, your next of kin often do not have sufficient cash in order to pay inheritance taxes. They then come under pressure to sell family assets - not because they want to, but because they see no alternative.

The solution: the right capital at the right time

Inheritance insurance is an life insurance product which is specifically designed to address this problem. The basic idea is simple:

• There is estimated What inheritance tax will be due at the time of your death;
• This amount will be insured; and
• In the event of death turns the insurer the insured capital from to your next of kin who can use this to pay the inheritance tax without having to draw on the family assets.

The ABA construction

To ensure the proper tax outcome of inheritance insurance, it is essential that the policy be set up correctly through a ABA construction:

• ‘A’ = the policyholder: the one who makes the contract and pays the premiums;
• ‘B’ = the insured principal: the person on whose life the contract rests. Upon the death of the insured head, the policy comes into payment;
• ‘A’ = the beneficiary: The person who receives the benefit after the death of the insured head and is therefore heir to the insured head.

Therefore, it is important that the heir who receives the benefit is also the one who takes out the policy and pays the premiums. Provided the policy is taken out that way, the benefit makes not part of the estate of the deceased and the distribution is not subject to inheritance tax.

What if, as a parent, you want to finance the premium?

Don't: pay directly

In practice, it is common for parents to pay the premiums directly, even though the policy is in the child's name. The result: in writing the child is the policyholder, but economic it is the parents who carry the contract.

However, whoever economically finances the contract may be considered by the Flemish Tax Office to be the actual policyholder. If the parents pay the premiums, there is a risk that the tax authorities will rule that the parents - not the child - are the true policyholders.

This shifts the construction from ABA to AAB:

• ‘A’ = the parent as policyholder and insured principal;
• ‘B’ = the child as beneficiary.

This has far-reaching consequences. After all, the capital distributed is then considered assets inherited by the child and is taxed in the inheritance tax.

Do: donate the amount of the premium

To avoid this, parents can first donate money to their child, after which the child uses those funds to pay the premiums himself. Thus, the child is both legally and economically the policyholder. After all, the premium payments come from the child's own assets - even if those funds were originally provided by the parents.

As a result, the ABA construction remains intact, and the insurance benefit is reduced upon death not taxed in inheritance tax. The fiscal impact then shifts to the gift itself - and it can be addressed in two ways.

Option 1: the registered gift

The most certain way to anchor the donation for tax purposes is through a registered donation (either through bank donation, either through notarial act), where in Flanders 3% gift tax is paid. At that point, the gift is finally settled for tax purposes.

Option 2: the unregistered gift

In the case of an unregistered gift writes the donor the funds by bank donation About to the child without paying gift tax. Does the donor die within five years of the gift, then the funds donated during this period are still taxed at the higher inheritance tax rates.

Notice:

• Only the donated funds may be affected fiscally, the distribution of the policy as such remains outside the scope of inheritance tax;
• As long as the donor lives, the gift can be made at any time be voluntarily registered (e.g., in case of illness of the donor within the suspected 5-year period). By still registering the gift, gift tax is paid and eliminates the risk of inheritance tax on those funds, regardless of when the death follows.

Conclusion

Inheritance insurance is an effective tool to support the to absorb inheritance tax for those who, on the one hand, are not yet ready to make a donation or want to take the time to make that choice deliberately, but on the other hand do not want to wait passively. Inheritance insurance provides sufficient liquid assets for your heirs to help pay the inheritance tax, so they won't be pressured to sell family assets. It's an approachable first step: financial protection today, further planning later.

Proper tax processing of the benefit relies on one essential premise: via the ABA construction the heir as policyholder enters into a policy whereby:

• He itself as beneficiary indicates; and
• He pays the premiums themselves with their own funds, which can be donated in advance by the insured head if desired.

Only in this way is it avoided that the distribution of the policy would be taxed in the inheritance tax in virtue of the heir.