16th December 2024

Inheritance Tax and Equity Release – Part 1

How does Equity Release affect Inheritance Tax, particularly in light of the forecast changes to Inheritance Tax brining in the value of pensions after 6 April 2027?

This article should not be considered as bespoke legal advice suitable to you and your circumstances. It also does not remove the need to seek appropriate financial advice from a suitably qualified professional operating in Equity Release mortgages. 

Inheritance Tax (IHT) is calculated on the size of your estate on death. Releasing equity in your home could, therefore, reduce the value of your property and lead to either less IHT being payable by reason of your death, or your estate may fall underneath the threshold completely so that no IHT is payable. In both cases, the equity release funds released must be spent and not retained in any form. As with any form of financial planning or Will making, you ought to consider the wider impact that the proposal has on your estate and in particular your family members if they are beneficiaries under your Will.

 

What is Equity Release?

Equity Release is a way to release funds locked up in your house without having to move out of the house or sell it. This article particularly looks at those who may wish to team Equity Release with Inheritance Tax planning. For those who are proposing to spend the released funds maintaining themselves or the property, this article has limited relevance.

The UK Equity Release market grew from approximately £1 billion in total lending during 2016 to four times that value by 2023. As far as demographics are concerned, homeowners aged between 65 and 74 represent the largest single demographic in the Equity Release market.  Equity Release can produce cash, which is taken as a lump sum payment, small regular payments or a combination of both. This article will make the working assumption that it is taken as a lump sum.

 

There are two main types of Equity Release Schemes in the UK:

Lifetime Mortgages

Lifetime Mortgages are the most seen version, whereby the homeowner borrows a portion of the property’s value with interest accruing over time. Repayment, including interest payment, is typically due only when the homeowner dies, physically moves house on a sale and purchase (and there is no portability across to the new property) or the homeowner moves into long term care. Any of these trigger points will result in the property being sold and the mortgage being paid off out of sale proceeds.

Lifetime mortgages can be tailored with options frequently being available to making interest only payments to service the mortgage or with the option to make no payments at all. These choices will influence the total debt accrued and ultimately the inheritance left beneficiaries and the Inheritance Tax bill.

 

Home Reversion Plan

With a Home Reversion Plan the homeowner sells a share of all or part of their property to the Reversion Provider in exchange for a lump sum or regular payments.  The homeowner retains the right to live in the property rent free until they die, or move into long term care etc, at which time the property is sold, and the Reversion Provider receives their share.

With such plans, the homeowner typically receives between 20-60% of the properties current market value. The percentage will depend upon the homeowner’s age and health factors which can impact the estate value for Inheritance Tax purposes.

 

When is Inheritance Tax due?

Inheritance Tax is a tax on the estate of someone who has died and includes the value of any lifetime gifts made in the seven years before the individuals death. It is important to realise that the spouse exemption (i.e. transferring one’s estate to your spouse or registered civil partner, if that individual is UK resident) often means that people die without there being an Inheritance Tax bill. This is by reason of the structure of their Will or the size of their estate and the effect of Intestacy provisions where there is no Will in place.

If your estate is passing to someone who is not a spouse and your estate, including lifetime gifts made to non-spouses in the previous 7 years before one’s death, is valued at more than £325,000 for an individual, or potentially £650,000 for a married couple/civil partner when the survivor dies, then your choice of beneficiaries will ordinarily be paying 40% on the value of the estate above that threshold. If you are passing through your Will your home to direct bloodline descendants for example a child, a stepchild, or a grandchild, the additional threshold allowance of a further £175,000 is available.

 

Inheritance Tax when gifting Equity Release funds

If you release equity in your home and gift the money to another person such as a child, this will be exempt from Inheritance Tax on your death providing you live for seven years after the making of the gift (and have not had any direct or indirect benefit measurable in financial terms back from that gift).

Should you die within seven years of the making of the gift, then the gift will be brought back into account with the rest of your estate when it comes to calculating the amount of Inheritance Tax then due.  For example, if you release less than £325,000 to a child or children and you then die, you will have no ordinary Nil Rate Band allowance available. If you give more than that figure to such non-exempt beneficiaries and you subsequently die between three and seven years after making the gift, then taper relief can be applied to the Inheritance Tax payable on those gifts by your choice of recipients of the gifted amounts.

Equity Release is also attractive because of the tax-free nature of the released equity.  The funds are not subject to Income Tax nor Capital Gains Tax (CGT) given that it is your principle main residence that the scheme operates over. This may make it more attractive than gifting investments standing at a gain to beneficiaries which may result in some form of Capital Gains Tax bill or Income Tax consequence for you.

 

It can therefore be seen that Equity Release coupled with gifting can effectively decrease the amount of Inheritance Tax payable by beneficiaries. That becomes even more critical when an asset class which was previously outside the Inheritance Tax net (your pension) will be brought into the tax net for Inheritance Tax calculation purposes on death should you die after 6 April 2027.

 

Part 2 will delve into the changes brought about within the October Budget to Inheritance Tax and Pensions which may impact Equity Release post April 2027. Click here to read part 2. 

 

To contact a one of our legal experts on the topics above, email info@bussmurton.co.uk or call 01892 510 222.

Edward Walter

Edward Walter
Partner