Does Equity Release Reduce Inheritance Tax?
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Author Paul Murphy
Implementing equity release into the retirement planning strategy
Does equity release help reduce inheritance tax? We explore the concept below.
In the financial year 2021/22, HMRC has confirmed they received the highest amount of inheritance tax since records began. They received £6.1 billion, an increase of 14% on the previous year (Source: HMRC).
Retirement & Lifetime Mortgages can provide a cash injection and a tax-efficient alternative to pensions, assets and investments for raising capital.
Lifetime-fixed equity release interest rates provide a secure solution for refinancing existing mortgage lending into retirement.
Plans provide the facilities to raise capital on a lump sum or drawdown basis. Later Life Finance provide a free annual review for clients to ensure the most suitable plan is in place.
If a more suitable solution is available this will be analysed alongside the existing plan to evaluate any exit fees and the overall net outcome to ensure the most economical outcome is established.
The wealth preservation aspect of equity release is where a knowledge gap still exists, (although this is improving with increasing awareness).
Intergenerational wealth distribution as part of a wider inheritance tax planning strategy is an area where demand for advice is growing, as the longer-term benefits of gifting become more apparent.
The seven-year rule for inheritance tax purposes is also a prime consideration for gifting lump sums. A pragmatic approach with early stage planning is crucial; ‘the earlier the better’ strategy is logical if you wish to release equity to gift.
The house price gap with younger people effectively being ‘priced out’ of the market also makes a strong case for utilising equity to assist families with home deposits- or other gestures, such as funding grandchildren’s education fees.
Does equity release help reduce inheritance tax?
When considering how equity release will affect inheritance tax, gifting and transferring property wealth with a lifetime mortgage and the associated tax planning advantages is an increasing area of interest for homeowners to reduce the impact of this tax upon their families.
Enjoying the benefits of gifting equity release funds whilst still alive and reducing the tax implications provides an attractive concept for homeowners.
Equity release and inheritance tax planning goes hand in hand with wealth distribution, preservation and a tax efficient strategy; family wealth can take generations to build; it is logical to plan ahead to ensure the impact of inheritance tax is minimised in the most efficient way possible.
No tax is due on any gifts you give if you live for 7 years after making the gift, unless the gift forms part of a trust. This is referred to as the ‘7 year rule’. If you die within 7 years of making a gift and there’s Inheritance Tax due on it, the amount of tax payable after your death depends on when you gave it. A ‘taper relief’ is applied between 3-7 years of making the gift.
When gifting from releasing equity, the money will not be taxed for inheritance tax purposes if you survive for seven years and don’t derive any direct or indirect benefit back.
If you die within the next seven years, the money gifted will be taken into account when calculating how much tax is payable by your estate.
When releasing equity from your home to gift funds, the money is due repayable on the last death (or long term care) of the homeowner, therefore any money gifted is deducted from the sale of the property and the estate.
The equity raised from the sale of the property is used to repay the equity loan and reduces the inheritance so this money is not liable for tax calculation purposes.
Lifetime Mortgages
A lifetime mortgage equity release plan can be used to gift a ‘living inheritance’ to family members whilst you are still alive.
A lifetime mortgage requires no regular interest payments therefore interest is rolled up and added to the sum borrowed. This will increase the level of borrowing and reduce the amount of equity remaining for inheritance purposes, although the advantages of advancing an early inheritance may be preferential for homeowners, especially when the wider tax advantages are considered.
Lifetime mortgages carry a negative equity guarantee to ensure your estate will not be liable to pay anything in the event of negative equity occurring if the value of your estate does not cover the funds owed.
Lifetime mortgages allow you to pay interest on a voluntary basis if you wish to control the level of money owed on the mortgage and reduce the effect of interest owing on the plan.
A reserve facility can be arranged with a lifetime mortgage to access additional funds in the future.
Inheritance tax is a tax due on the estate of someone who’s died. The amount of tax due depends on the value of the deceased’s estate – which is worked out based on their assets (cash in the bank, investments, property or business, vehicles, payouts from life insurance policies), minus any debts including mortgages and equity released from their home.
Inheritance tax threshold
There is normally no IH tax to pay if:
- The total value of your estate is below £325,000, OR
- You leave everything over £325,000 to your spouse, civil partner, a charity or an amateur sports club
If neither of the above apply, your estate will be taxed at 40% on anything above the £325,000 threshold when you die (36% if you have left at least 10% of the value after any deductions to a charity in your will).
Inheritance tax rules if you are married
Special rules apply for married couples or those in civil partnerships:
- When you die, assets left to your spouse or registered civil partner are exempt from inheritance tax, provided they’re living in the UK.
- In addition to this, your partner’s inheritance tax allowance rises by the percentage of your allowance that you didn’t use, therefore a a couple can currently leave £1 million tax-free (2 x £325,000 tax-free allowances + 2 x £175,000 main residence allowances).
Gifting funds and Inheritance Tax
If gifting money from releasing equity, the money will not be taxed if you survive for seven years and don’t receive direct or indirect benefit back.
However, if you die within 7 years of gifting the funds, it will be brought back in to account with the rest of your estate when calculating the tax.
Is Equity Release Subject to Inheritance Tax?
Equity release is an option for older homeowners to consider if distributing the wealth built up in their homes to family is a consideration, however understanding how equity release affects the impact of tax due is important to clarify the overall implications.
For many people their home will form most of their estate, which ultimately makes this an important decision to make.
Equity release is tax free and not subject to Income Tax as it is not a form of income, as it is a mortgage. Since the lending is taken out against your home, this is not taxable for income or capital gains tax.
Even if you are planning to Release Equity to supplement your income, you are not subject to any taxation on the money released.
1. How can equity release save inheritance tax?
By reducing the size of your estate when you pass away, equity release provides a method of raising cash from your home without downsizing to spend as you wish.
As the money borrowed plus interest is deducted from your estate upon death or long term care, this helps reduce any tax due payable.
2. How does equity release affect inheritance?
Raising money from your home will reduce the amount of inheritance as the equity release is repaid from the sale of your home when you pass away or go into long term care.
Homeowners are increasingly gifting an early inheritance with money from equity release funds raised to enjoy the benefits of gifting and receiving whilst they are still able to.
3. Does Gifting reduce inheritance tax?
Gifting money to family is a popular way of reducing the amount of tax payable. Equity release with a lifetime mortgage is a common method of raising equity to gift to family members.
Gifting an early inheritance can be done via special mortgages which give you the power to safely unlock tax-free equity from your home. Repayments are optional and home ownership is retained for life.
The benefits of gifting cash by utilising the wealth in your home can be used to distribute funds to your family. This can also form part of your tax plan for the future.
If you make a gift and survive for 7 years or more, the gift can be tax-free, making this gesture a popular method of distributing and preserving your hard-earned wealth.
Is Equity Release a Good Idea To Avoid Inheritance Tax?
Releasing equity is a popular way of reducing the amount of IH tax payable as it decreases the size of your estate when you pass away.
Avoiding inheritance tax completely will rely on various factors, however Equity release via a lifetime mortgage is a common method of raising cash from property whilst you are alive.
How does equity release affect the probate process?
Equity release is repaid within 12 months of the last surviving homeowner passing away or going into long term care.
Firstly, your beneficiaries will need to contact your lender and provide a copy of the death certificate and probate document in order to communicate with the executors of your estate.
The executors of your estate will have control over marketing the property with an estate agent. When the property is sold, the outstanding balance owing is settled and after any professional fees such as legal costs are settled the residual balance will be paid to your estate.
How does equity release work when someone dies?
Equity release is repaid within 12 months of the last surviving homeowner passing away or going into long term care.
On first death or long-term care, the plan continues until the surviving homeowner passes away or goes into long term care. Then the property is sold, and the plan is settled.
Gifting an early Inheritance and Equity Protection Options
Lifetime mortgages are now available with an inheritance protection safeguard option to ensure a proportion of your home can be protected for inheritance purposes.
As mentioned earlier, many homeowners and their families are enjoying the mutual benefits of gifting a ‘living inheritance’ using a lifetime mortgage.
A gift of equity for a home deposit, for example, can help reduce the ‘loan to value’ of borrowing a family member may require on their new home and provide multiple advantages over having to raise a larger mortgage when getting ‘onto the housing ladder’.
(For families fortunate enough to be in existing homes, a gift for home improvements, or simply a cash injection can still be arranged).
The concept of gifting existing equity to assist a family member to secure their own equity on a new home is an interesting concept; It makes logical sense for families and helps ensure the funds used in a ‘living inheritance’ are being put to practical use for added peace of mind when giving money to family.
New research by the equity release lender More 2 Life showed the benefit of gifting a home deposit from equity release.
“By sharing the average amount of equity gifted to fund a deposit (£69,376)** with children or grandchildren, over-55s could help them to secure a lower LTV (Loan to value) and therefore a lower rate mortgage.
Should the first-time buyer be able to pay the same monthly repayments as someone who purchased without this level of deposit, they could substantially reduce the time taken to pay off their mortgage.”
Reduction in time taken to pay off 25-year mortgage by augmenting a deposit with average equity release gift amount of £69,376
| Region | Average FTB house price*** | Time saved on paying off a 25-year mortgage |
| London | £436,375 | 5 years |
| South East | £280,860 | 7.4 years |
| South West | £236,376 | 9.3 years |
| East of England | £263,478 | 7.8 years |
| West Midlands | £185,476 | 10.9 years |
| East Midlands | £184,151 | 12.4 years |
| North West | £160,501 | 13.7 years |
| Yorkshire & The Humber | £159,899 | 13.8 years |
