Equity release can be a great financial tool to provide a lump sum or regular income of tax-free cash. But how does it affect your Inheritance Tax (IHT) liability, and can you use it for IHT planning?
Equity Release plans provide tax-free cash, which can be spent or gifted outside of your estate to reduce your Inheritance Tax (IHT) liability. Upon death, your IHT bill is calculated from your assets, less your liabilities. Equity Release will need repaying, reducing your estate's value and minimising your IHT bill.
However, you need to consider essential aspects of using equity release for Inheritance Tax planning. Including how it affects the calculations and why it could be a better option than releasing monies from your pension.
How can equity release help with Inheritance Tax planning?
Equity release can help with Inheritance Tax planning by lowering the IHT liability on your estate.
When calculating your IHT bill on your estate's total value, equity release is a liability. Therefore it must be deducted from your total assets, reducing your estate's net worth.
If you decide to take equity release, the lender will place a charge against your property (similar to a standard mortgage). This needs repaying upon death or when you move into a care home.
Equity release is easy to use for IHT planning, as the interest rate secured on your loan is fixed-for-life, meaning it will not change in the future. This lets you to know exactly how much interest will accrue over time and what the liability will be at any given point.
We can work alongside your tax planner, who will calculate the most efficient sums you can release.
Inheritance Tax on gifted equity release monies
People who use equity release for Inheritance Tax (IHT) planning commonly gift the monies to their beneficiaries as an early inheritance.
Not only does this allow you to see your loved ones enjoy using this money before you pass, but it also lowers your estate's value.
Having a lower-valued estate could reduce your IHT liability as there's no IHT to pay on the gift if you live for seven years after gifting money.
However, the gifted funds could be subject to IHT if you pass away within seven years of the gift. This is calculated using a reducing scale, known as 'taper relief'.
Taper Releif:
| Years since the gift |
Tax amount |
| Less than 3 |
40% |
| 3 - 4 |
32% |
| 4 - 5 |
24% |
| 5 - 6 |
16% |
| 6 - 7 |
8% |
| 7 or more |
0% |
The gifted monies can be spent on anything, including helping children and grandchildren get onto the property ladder - which is becoming increasingly difficult nowadays. All while reducing your potential IHT bill.
How is Inheritance Tax (IHT) calculated?
Inheritance tax is a tax calculated on your estate after you pass away.
Estate definition: All the money and property owned by a particular person, especially at death.
Not everyone pays it, and the current threshold for an individual is £325,000. So if your estate is worth less than this when you pass away, you will not pay any IHT.
Any amount above your threshold would be subject to an Inheritance Tax of 40%.
However, this threshold can increase. If everything above the threshold was left to any of the below, you effectively transfer your allowance to another person/organisation. Therefore the £325,000 increases to £650,000.
- Spouse
- Civil partner
- Charity
- Community amateur sports club
In some cases, you can increase the IHT allowance further. If you leave your home to your children, stepchildren, or grandchildren, the limit increases to £475,000.
This is called the 'Residence Nil Rate Band' and was introduced in April 2017.
Any unused amount can be transferred and added to the partner's threshold for married couples or civil partnerships. Therefore, it is possible to create a maximum limit of £950,000 for the estate, which is free from IHT.
However, if you have liabilities to your estate (debts), such as equity release, they will need to be paid first. This will reduce your estate's net worth and could result in having less value assessed for IHT.
IHT Example: No Equity Release
Your property is worth £600,000, and you have £100,000 in investments, savings, and other assets (including your car and furniture). Therefore your total estate is worth £700,000 (including your property).
You have no existing mortgages.
Estate (£700,000) - the individual allowance (£325,000) = £375,000.
Inheritance Tax calculated at 40% of £375,000 = £150,000.
Therefore, the total IHT to be paid is £150,000.
Reducing Inheritance Tax with equity release (3 Examples)
Example one:
Your property is worth £600,000, and you have £100,000 in investments, savings, and other assets (including your car and furniture).
You have an equity release with £300,000 balanced owed.
Therefore your total estate is worth £400,000 (property + other assets - equity release balance).
Estate (£400,000) - the individual allowance (£325,000) = £75,000.
Inheritance Tax calculated at 40% of £75,000 = £30,000.
Therefore, the total IHT to be paid is £30,000.
You made a saving of £120,000 by using equity release.
Example two:
You jointly own a property with your spouse worth £1,000,000 and have investments, savings, and other assets (including your car and furniture) of £300,000.
You have an equity release with a balance of £400,000 owed.
Therefore your total estate is worth £900,000 (property + other assets - equity release balance).
You pass away first and leave your share of the property and investments to your spouse. Your IHT allowance passes to them.
Your spouse passes away, and they now have an IHT allowance of £650,000.
Estate (£900,000) - the total allowance (£650,000) = £250,000.
Inheritance Tax calculated at 40% of £250,000 = £100,000.
Therefore, the total IHT to be paid is £100,000.
You made a saving of £160,000 by using equity release.
Example three:
Your property is worth £750,000, and you have £250,000 in investments, savings, and other assets (including your car and furniture).
You have an equity release with a balance of £250,000 owed. You originally gifted the funds to your children.
Therefore your total estate is worth £750,000 (property + other assets - equity release balance).
You make interest payments for the plan's first three years, maintaining the balance at £250,000. You pass away in the fourth year.
Estate (£750,000) - the basic allowance (£325,000) = £425,000.
Inheritance Tax calculated at 40% of £425,000 = £170,000.
You are also charged 24% of the gift of £250,000 = £60,000.
Therefore, the total IHT to be paid is £230,000 (£170,000 + £60,000)
You made a saving of £40,000 by using equity release.
When is Inheritance Tax due?
You must pay Inheritance Tax by the end of the sixth month after the person dies. For example, if the person dies in January, you must pay the Inheritance Tax by 31 July.
Source: gov.uk/paying-inheritance-tax
HM Revenue and Customs (HMRC) will charge you interest if you do not pay by the due date.
The 'executor' of your estate is responsible for paying your Inheritance Tax liability from your estate. Therefore, appoint someone as part of your Will whom you trust to handle this process.
Remember: if someone who is married or in a civil partnership passes away and leaves all assets to their partner, they can transfer their unused allowance to their partner.
The impact of equity release on private pensions (IHT exemption)
Any private pension fund can be held in special trusts outside of your estate for Inheritance Tax calculations.
Therefore, one option is to use equity release to support your living instead of withdrawing from your private pension. You can then pass your pension fund outside your estate without needing to pay any IHT.
A specific type of equity release can be ideal in this scenario, called a drawdown plan.
Drawdown plans allow you to release an initial lump sum and place a pre-agreed amount into a reserve facility.
The lender does not charge interest on the amount held within the reserve until you withdraw from it, typically in minimum amounts of £2,000.
Drawdown plans can be ideal for providing a regular income while reducing the value of your estate for IHT planning purposes.
How we work alongside your financial planner
Equity release advisors cannot calculate the best amount of funds needed to reduce your IHT liability. Instead, you will need a qualified financial planner to calculate this for you.
Our equity release advisors are trained to work alongside financial planners to help you obtain the best outcome.
A financial planner can give you an idea of the amount of equity release funds you need and when you should take them. This includes each drawdown amount from a reserve facility if you wish to have one.
Your equity release advisor can find the most suitable plan that cost-effectively meets these requirements.
Your advisor will also consider your future plans and discuss some plan features that could provide extra protection.
If you have further questions, why not speak with one of our qualified advisors?
Call us on 0207 158 0881 or use our online form to book your FREE consultation.
While a qualified equity release advisor has written this guide, it is not intended to be used as financial nor legal advice and should not be relied upon.
To understand the full features and risks of an Equity Release plan, ask for a personalised illustration.
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