Equity release and its impact on inheritance tax

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Equity release allows you to access cash tied up in your home to gift to loved ones or spend how you choose. But equity release can also impact inheritance tax and what you can leave behind for others.

This guide covers everything you need to know about equity release and inheritance tax (IHT) so you can decide if it’s right for you.

How does equity release affect inheritance tax?

Equity release products such as lifetime mortgages enable you to unlock equity from your home. Think of it as a loan secured against your property that’s repaid when you die, or the last borrower moves into long-term care.

How you spend the money is up to you, whether it’s to enjoy your retirement or gift to family and loved ones. But if your beneficiaries were to inherit a property with equity release, how would it affect inheritance tax liability?

Your property is likely to be your most valuable asset, representing the majority of your estate. If your estate is worth £325,000 or more, your chosen beneficiaries may have to pay a 40% inheritance tax on anything above that threshold when you pass away. If your estate is worth less, they usually won’t have to pay any IHT at all.

However, equity release could minimise the IHT liability by reducing the total value of your estate in two ways:

• Your estate will be worth less because you’re accessing the equity that has built up over time
  
• Money used from the sale of the property to repay the equity release loan is deducted from any inheritance, so your estate decreases in value and less IHT is due

It may be that equity release can help you achieve your retirement goals or make a gift to others when you’re alive. It is important to seek professional retirement planning advice and explore your options before going ahead with equity release.

What is equity release?

If you’re 55 or older and live in the UK, equity release is a way of borrowing money against your home’s value. How you spend the money is up to you, but some common examples include:

There are different types of equity release, and the one you choose can significantly impact what inheritance you can leave to others when you’re gone.

Lifetime mortgage

With a lifetime mortgage a loan is secured against your property that allows you to continue living in your home while enjoying tax-free cash to fund your retirement, gift to others or use however you like.

In most cases, the loan isn’t repaid until the last borrower dies or goes into long-term care. Equity release also uses compound interest where the interest you pay is based on the loan’s value plus the interest already accrued.

Equity release providers like LV= are members of the Equity Release Council where products come with a ‘No Negative Equity’ guarantee. This means the amount that needs to be repaid won’t exceed the value of your home when it’s sold, and your beneficiaries will not inherit any debt. If the property sells for more than the outstanding loan amount, the remaining funds can be left to others and could incur inheritance tax depending on the value of your estate.

Home reversion plans

With home reversion plans you raise cash by selling all or part of your home to a loan provider. You can carry on living in your home for the remainder of your life. When the last borrower dies or moves into long-term care, your provider is paid from the proceeds of the sale of your home.

If you’re selling a share of your property, you can guarantee to leave at least some inheritance when you pass away. But you’ll have to sell the share at a rate that’s typically less than the current market value. So, if you sell a 25% share worth £200,000, you may receive significantly less than £50,000 on the basis that your lender may not receive their money for many years.

Please note, LV= does not offer a home reversion plan option.

What is inheritance tax?

Inheritance tax refers to the tax that’s paid on a person’s estate when they die. As mentioned, the amount depends on the total value of the estate including property, savings, investments, possessions and more.

As a rule, the following applies:

• You won’t pay inheritance tax where the value of the estate is less than £325,000, or everything above that threshold is left to a spouse, civil partner, or charity.
  
• You’ll pay 40% inheritance tax on any amount over the £325,000 threshold that’s left to family and friends.
  
• Married couples and civil partners can pass their unused tax-free inheritance tax allowance to their surviving partner.
  
• If you gift your home to your children or grandchildren, the inheritance tax threshold can increase to £500,000. This also applies to adopted and foster children as well as stepchildren.

Does equity release reduce inheritance tax?

Equity release can reduce the amount of money you can leave your loved ones and beneficiaries when you die.

Inheritance tax calculations are based on the value of your estate. Taking equity out of your property will reduce your estate’s total value and could lower your IHT liability.

The amount of IHT due can depend on how you structure your estate. Take the following example:

Person A is single with a property worth £500,000 and other assets of £100,000, taking the total value of their estate to £600,000. Person A takes out equity release to fund their retirement. If they die owing the lender £150,000, the following will apply:

Here, taking out equity release could save Person A £60,000 in inheritance tax and allow them to enjoy the money tied up in their property now or gift it to others. Remember that compound interest applies to a lifetime mortgage and therefore the outstanding balance can grow a lot over time. The amount being saved on inheritance protection could be less than the amount of interest which has accrued, so overall your beneficiaries may not be better off. Talking to a financial adviser can help you work out what is best for everyone involved. 

There are also alternative ways to gift money to loved ones that could be more suitable.

If your home is gifted to a direct descendent, you may also be entitled to the £175,000 residence nil-rate band (RNRB) per person. In this case, Person A’s beneficiaries may owe nothing in IHT if it was applied.

If unused, the RNRB inheritance tax free allowance can be transferred to a surviving spouse or partner in addition to the £325,000 IHT limit. Together, they allow married couples and civil partners to pass on property values up to £1 million from of inheritance tax to their direct descendants.

What if I inherit a house with equity release?

If you inherit a house with a lifetime mortgage, you’ll be responsible for settling the outstanding balance with the lender once the last borrower dies or enters long-term care.

Most equity release providers require the lifetime mortgage to be paid off within 12 months, although interest will continue to be added during this time and until the total debt is paid.

If you’re the beneficiary of an estate that includes a property with a lifetime mortgage, your repayment options typically include:

If you pay off the equity release with another mortgage or other funds available to you, the no-negative equity guarantee won’t apply and you’ll need to pay off the total outstanding balance, even if this is higher than the property value.

Equity release and inheritance tax: What other options exist?

We’ve explored how equity release can help you manage your estate and reduce your inheritance tax liability. But other options may be available when it comes to funding your retirement or leaving money behind for others:

• Put the money into a trust: Life insurance trusts can help avoid inheritance tax as the proceeds aren’t normally included in your estate and can be passed on tax-free to your beneficiaries.
  
• Gift the money while you’re alive: If you live for seven years after gifting money to others, no inheritance tax is due. This means you’ll get to see your loved ones enjoy your generosity.
  
• Take out income drawdown: Also known as a pension drawdown or investment drawdown, it allows you to withdraw money from your pension as a lump sum or in regular payments, boosting your retirement income.

Need more information about your equity release and inheritance tax options?

Our equity release experts are available to talk you through the process of equity release and its impact on inheritance tax. Request a call back today.