A brief guide to usufruct using life insurance
In addition to individual pension provisions and wealth preservation, life insurance can also be used in succession planning and to provide financial security for your family. Using the right structure, and with timely planning, any negative impact on the liquidity of your beneficiaries can be reduced significantly, or even entirely avoided. One attractive option is usufruct i.e. granting a life interest. The term 'usufruct' is frequently used in connection with a lifelong right, e.g. transfer of a leased property to one's children and derivation of all related benefits. This means that the donor retains a life interest in respect of the gifted asset for as long as he or she lives; in this case, this would relate to the annual rental income. In the context of the German Inheritance Tax Act, granting a life interest is particularly attractive, since the capital value of the life interest charge increases almost annually as a result of increasing life expectancy. If the favourable legal position is applied to insurance contracts, this gives rise to attractive financial advantages. The younger the donor (= beneficial owner of the usufruct right), the higher the gift tax savings.
Let us take the fictitious example of the Meyer family from Germany: the high-net-worth parents (father aged 60, mother aged 55) wish to pass on assets to their children tax-free up to the exemption threshold and reserving the maximum life interest. Let us show you how it works.
Mr and Mrs Meyer (aged 60 and 55 respectively), with their children (son, aged 30, and daughter, aged 27), aim to make provisions for the future and, over the long term, wish make a substantial contribution to preserving their family’s wealth. Here, the question of future inheritance tax plays a key role. The parents are willing to gift part of their wealth now, but naturally they wish to do so with ideal effect. This is where gifting a life insurance policy with reservation of a life interest (‘usufruct’) comes in. They would like to learn what maximum amount they can currently pass on to their children free of gift tax.
- Exempted amount per child and per parent: EUR 400,000.00 (every ten years)
- Calculation of maximum amount under reservation of a life interest from both mother and father
- Conclusion of two separate life insurance policies (the respective parent is both the policyholder and the insured person)
- When the benefit under the policy becomes payable (upon death or survival), in each case one child is named as the beneficiary.
- After conclusion of the policy, at no cost, each parent assigns an insurance policy to one of the children (= new policyholder).
- The proceeds under the policy continue to be due to the donor (usufruct in respect of life insurance).
- Following the decease of the usufructuary (donor – parent), the usufruct / life interest, is extinguished.
Gift tax is calculated below, taking the example of the mother/father gifting to their son, as follows:
|Value of gift (tax value)||EUR||2,000,000||or||1,250,000|
|Capital value of usufruct (life interest)||EUR||-1,602,688||or||- 864,113|
|Tax value of gift||EUR||397,312||or||385,887|
|Personal exempt allowance||EUR||- 400,000||or||- 400,000|
This means that, in our example, currently the Meyer family could each gift EUR 3,250,000.00 to their children with a reservation of beneficial interest, without triggering any tax liability. In other words, without the usufruct arrangement described, gift tax per child of EUR 465,500.00 (mother: 304,000 / father: 161,500) would be due.
In addition to the financial advantage of such an arrangement described, using a life insurance policy has further benefits to offer:
- Since the benefit payable on death does not form part of the deceased's estate, the beneficiary (the child) does not need to await distribution of the estate -> a so-called 'certificate of inheritance' is not required, and the sum insured is paid out directly to the beneficiary.
- Neither does the beneficiary bear any liability for debts of the estate (potentially following a requisite rejection of inheritance); the beneficiary will still receive the sum insured (see above).
- Moreover, if the usufructuary (parent) dies, the benefit on death will be paid out to the policyholders (the children) free of inheritance tax and income tax.
Arrangements involving life insurance policies are ideally suited to clients resident in Germany (shown here using the example of usufruct / reserved life interest) for the purposes of succession planning, providing security to family members and significantly improving the liquidity position of the next generation. At the same time, the interests of the older generation can still be preserved, because they are still provided for.
Since the topic of usufruct is a complex one, we would recommend that you refer to a tax expert/specialist lawyer as part of your consultations. If you have any questions, please do contact us.