Does Equity Release reduce inheritance tax?

Your house is probably the largest asset you own, and will probably represent most of your estate when you die. When you release equity from your home, does it reduce your inheritance tax liability?

Equity Release reduces the total value of your estate, so by releasing equity you could help minimise your inheritance tax (IHT) liability when you die. 

The overall value of your estate is reduced in two ways, firstly when you free up equity, cash for yourself, the value diminishes. Secondly the money used from the property to repay the Equity Release loan is also deducted from the inheritance, so the value of your estate reduces.

However, it’s not completely black and white, there are some caveats to consider.

What is the inheritance tax threshold?

A direct descendant, like a grandchild, child or stepchild, can inherit your home. This raises the tax-free threshold for each spouse or partner by £150,000 (for the tax year 2019/20) to £475,000 for each person.

When is Inheritance Tax due?

IHT is a tax on the estate of someone who has died and on any lifetime gifts they made in the 7 years before their death.

You have to pay it unless you use the spouse exemption, which means that you can give your whole estate to your spouse or registered civil partner, so long as they live in the UK.

In the UK, if you don’t do this and your estate is worth more than £325,000 for an individual or potentially £650,000 for a married couple/civil partner when the first spouse or partner dies, then your beneficiaries will have to pay 40% of the amount over this threshold.

Inheritance Tax when gifting Equity Release funds

If you gift someone money by releasing equity, this money will not be taxed if you live for seven years and don’t get any money back. However, if you die within the next seven years, the gift will be taken into account when figuring out how much tax is due.

Giving more than £325,000 to a non-exempt recipient and dying three to seven years later may cause a tax liability.

Lifetime mortgage and inheritance tax planning

Inheritance tax planning can be complemented with a number of Equity Release products. A lifetime mortgage can help reduce the amount of inheritance tax you payable.

Here’s a couple of examples to illustrate the different ways a lifetime mortgage can be used to compliment Inheritance Tax Planning.

Example 1

Mr and Mrs Smith are 71 and 70 years old respectively. They own their home outright and it’s worth £1,500,000. They have a comfortable lifestyle and their income covers their usual expenses, they can afford to go on holiday but there’s very little leftover.

They have one daughter and three grandchildren. A lifetime mortgage with a reserve facility will allow them to drawdown ‘small amounts’, between £2,000 and £10,000, as and when they wanted/needed it.

This may enable them to take advantage of the various gift allowances available. Each year, they can make gifts of up to £3,000* without incurring IHT. This means they can each give £6,000 away. They can also make as many little gifts of £250* as they choose, as well as a wedding gift of £2,500* to each grandchild. Gifts to charity or political parties are also tax free.

Example 2

Using a Lifetime Mortgage to reduce inheritance tax, Mrs Jones is 78 years old. She was widowed 5 years ago and her husband left all of his wealth to her. She owns a bungalow worth £2.5million and her assets are worth around £300,000. She has two daughters who will be the sole beneficiaries of her estate.

Without any IHT planning her daughters could be faced with a large IHT bill, £740,000 based on a £2.8million estate. Equity Release with a lifetime mortgage of £1.2million has allowed her to make gifts of £600,000 to each of her daughters while still retaining £1.3million in equity in case she needs to move into care or downsize.

Her daughters have agreed to pay the interest on the lifetime mortgage each month keeping it at £1.2million. Providing she lives for at least seven years these gifts fall outside of her estate for inheritance tax purposes.

The remaining debt will reduce of the value of her estate by £1.2million, which in turn will reduce of even eliminate the IHT bill saving around £740,000.

if you are looking to take Equity Release on a leasehold property such as a flat then visit this topic.

What happens if you inherit a house with Equity Release?

If you inherit a house with an active Equity Release mortgage, it will be down to the executor of the estate to repay that lifetime mortgage and interest. They may have to sell the house to do this, in which case you’d be entitled to any proceeds left from the sale of the home, it is possible that no equity remains in the property and all proceeds of the sale are required to repay the Equity Release plan.

How can Joslin Rhodes Help?

When considering Equity Release, it is critical that you also get the right advice on Inheritance Tax planning, as the two go hand in hand. You should never release equity just to reduce your chances of having to pay IHT. By speaking to one of our advisers you’ll get specific estate planning advice relevant to your personal situation.

For further reading…

Can I pay off an Equity Release loan early?
Is Equity Release Regulated by the FCA
Equity Release VS Remortgage