For those looking to pass on wealth while trying to simultaneously reduce tax on the proceeds, Section 73 investment plans offer a potential solution. These plans are specifically designed and sold to try manage Capital Acquisitions Tax (CAT) liabilities on gifts, and to provide a potentially tax-efficient way to transfer assets to loved-ones. But do they work? Lets explore!

What is a Section 73 Investment Plan/ Policy?

Firstly, lets look at what a Section 73 investment plan (policy) is and what it’s designed to do . A Section 73 policy is designed to enable individuals to set up a regular contribution savings investment policy that accumulates and grows over time. These funds are then used to pay the CAT due on future gifts to your beneficiaries, trying to ensure a more cost-effective transfer of the future wealth and the proceeds of the savings plan!

A Section 73 plan is typically established by signing-up to an insurance company policy via a broker or via the company directly. Once you set it up properly, you then begin making regular (monthly/quarterly/annual) contributions into the policy.

Section 73 Policy Requirements (per Revenue)

• Minimum Duration: The policy must be in place for at least eight years before the gift is made and the tax liability arises (otherwise it’ll be taxed fully along with any other gifts you’re passing)
• Specific Purpose: The policy must be established under Section 73 of the Capital Acquisition Tax Consolidation Act 2003, with a clause or endorsement confirming this purpose (it’s not just any old savings plan dear reader!)
• Premium Payments: Must be made by the disponer (the individual giving the gift, you!) and not by the beneficiaries.
• Trust Setup: Often structured within a trust for the designated beneficiaries, although the distribution of proceeds can remain flexible and subject to change in future
• See Revenue.ie here for full details

Practical Considerations & Commissions!

• Regular Contributions: Payments must be made monthly, quarterly, or annually
• Investment Flexibility: As you’ll most likely be buying the policy from an insurance company you’ll have access to their rage of funds to invest the proceeds. You’ll have the choice of investing in equity, property, bond, alternatives or cash funds etc etc etc!
• Change of Mind: The ‘saver’ can change their mind as to the future use of the savings in future, and can cash-in and buy a Porsche for themselves if they wanted, provided they do so before the gift is made of course!

Key Benefits of Section 73 Plans

• Flexibility: Unlike Section 72 policies (which I wrote about here), you have more flexibility and less of a financial commitment with a Section 73 policy
• Tax-Free Lump Sum: Proceeds from the plan are tax-free when used to pay CAT on gifts
• Estate Planning Flexibility: Potentially provides a strategic way to transfer wealth to beneficiaries with reduced tax payable

Commission-based advisors: Not so much a benefit as an important note! Based on most commission contracts with insurance company providers, commission-based advisors can ‘only’ get c10% of Year 1 premia as a commission when they sign you up. So if you save €50,000 per year, they get max €5,000 commission. Might sound like a lot but when compared to Section 72 policies (which are Whole of Life Protection Policies), they can get up to 100% of your Year 1 payments as a commission on sign-up, plus c30% of each subsequent years’ premia. So you can see some less professional advisors may push Section 72 policies very hard at you even if a Section 73 might be more advantageous for your circumstances.

Key Risks of Section 73 Plans

While Section 73 plans offer substantial benefits, they also come with certain risks that should be carefully considered, and I’m not just being pessimistic here!

• Investment Risk: The value of the investment can rise and fall of course, and there is a possibility that you could get back less than you originally invested. This could potentially negate the advantage of setting up the plan in the first place
• Market Timing Risk: If the proceeds of the policy are passed to beneficiaries during a market downturn or correction, the value of the investment could be significantly reduced. In such cases, the plan might not provide the intended tax relief advantage at all, and could be a net loss
• Fees: Given they are insurance-based schemes, some Section 73 plans come with hefty fees, which can eat into the investment returns. Depending on the provider and the broker commissions, you will usually pay between 1.5% and 3% annual fees. And if you end up in ‘sub optimal’ funds, it would further limit the potential upside of your investment
• Commitment Risk: While you can bail out at any time, in order to see the benefits, these plans require a long-term commitment. They need to be in place for at least eight years. If circumstances change and the policy no longer suits your needs, the fees and potential losses may outweigh the benefits
• Future changes in tax legislation could affect the advantages of Section 73 plans. Regular reviews with a tax advisor can help adapt your strategy to new laws and maximise benefits.

Example: Estate of €3 Million, 1 Child Beneficiary

The facts and pros and cons are all fine and well, lets look at a specific example. Let’s consider a scenario where a parent wishes to leave their entire estate, valued at €3 million, to their child. It’s not an everyday scenario but it helps paint the potential win quite clearly. In this scenario, the child has already used up their lifetime CAT allowance, meaning the entire €3 million will be subject to CAT if it passes to them.

• Gift Amount: €3,000,000
• CAT Liability: €990,000 (33% of €3,000,000)
• Traditional or Do Nothing Approach:
• The parent would need to gift an additional €1,477,612 to cover the €990,000 CAT liability, as this extra amount would also be subject to CAT. Or, they do nothing and let child pay the tax bill by selling or disposing of €990k of the estate (if that’s feasible, possible or desirable).
• Section 73 Approach:
• Set up a Section 73 policy to try accumulate €990,000 over 8 years minimum (you need to start this at least 8 years before the last survivor dies of course!!)
• Estimated monthly premium: €8,450 per month (101k per year), achieving 5% return average for 8 years gets to €990,000. You’ve paid in €811k over those 8 years, the assumed growth has done the rest
• Upon the parent’s passing, the €990,000 proceeds from the policy can be used to cover the CAT liability, allowing the child to inherit the full €3,000,000 without any further tax burden.
• The family potentially ‘wins’ here. But it’s not all that crystal clear if you follow it through – bear with me!

Bear With Me………………..

If we think about the above example – was it really that amazing!?

• The family would have had to have been able to contribute the €101k per year to the scheme, right!!?
• Unless there was huge excess cashflow, they have had to repurpose invested cash or pension pots to try do that level of savings!?
• Would it make sense to have to generate higher income from pension pots, pay more income tax on those incomes, just in order to put it into a Section 73 policy!? Likely not.
• If they did decide to ‘re-purpose’ assets, where there was not excess incomes to support the monthly savings, then it may or may not make sense – depending on what the assets were in before being re-purposed! If they are sitting in a current account, then there is a probability that they would be better off….

If there was say €500k sitting at 0.0% interest, and that it’ll pass to child in 8 years – the €500k will be taxed at 33%. After paying €165k tax, the €500k becomes €335k in the child’s hands. If however, that €500m was dripped into a Section 73 regular savings plan, ignoring potential returns for now. In that scenario, the child will inherit the €2.5m non-Section 73 assets (it was €3m but €500k went into the Section 73, right!). The tax bill on that will be €2.5m will be €825k. They €500k from the Section 73 policy will reduce that CAT bill down to €325k.

In the original ‘do nothing’ scenario, the child got €2m of the €3m into their hand after CAT tax. In this scenario, where they have used saved €500k of the €3m into a Section 73 policy, the child gets just under €2.2m net after the tax bill. A more modest ‘win’ of c€190k. But still it’s a c10% win, or at least a potential c10% win!

Paddy Delaney

Conclusion

Section 73 policies offer a potentially useful tool for managing CAT liabilities, particularly when planning to leave substantial estates to beneficiaries who have exhausted their CAT allowances, and where there is excess cash to be allocated on a monthy or annual basis consistently for 8 years minimum.

They do come with risks that must be carefully weighed and considered in advance, such as the potential for investment losses, fees, and market timing issues. Almost irrespective of the size of one’s estate, these plans can offer families a means to potentially reduce the tax payable on their inheritance, preserving wealth for future generations and/or loved-ones.

I hope it heps.

Paddy Delaney QFA RPA APA

—————————————————————————————————–

___

Disclaimer

___

The content of this site including blogs and podcasts is for information purposes only. Everybody’s financial situation is different and the content we share on our site and through podcasts may not be applicable to you. 

The articles, blogs and podcasts are not investment advice. They do not take account of your individual circumstances, including your knowledge and experience and attitude to risk. Informed Decisions can’t be held responsible for the consequences if you pursue a course of action based on the information we share