Equity release and inheritance tax constitute an important consideration for homeowners looking to unlock the value of their property while planning their estate.

As homeowners approach their golden years, managing their property wealth becomes increasingly crucial, particularly when it comes to inheritance tax planning.

This comprehensive guide delves into the relationship between equity release and inheritance tax, empowering you with valuable insights to secure your legacy.

What Is Equity Release?

Equity release is a type of later-life lending that enables homeowners aged 55 and above to convert a portion of their home’s value into a lump sum or drawdown facility.

Types of Equity Release Plans

There are two main types of equity release.

The two types are:

• Lifetime Mortgages: The most common form of equity release, a lifetime mortgage allows you to borrow a percentage of your home’s value while retaining ownership.
• Home Reversion Plans: With a home reversion plan, you sell a portion of your home to a provider in exchange for cash, while retaining the right to live in the property for the rest of your life.

Pros and Cons of Equity Release

Equity release can be a practical solution for some homeowners, but it’s essential to weigh the potential advantages and disadvantages carefully.

These include:

Pros	Cons
Access tax-free cash without selling your home	Interest rates can be higher than traditional mortgages
Can help with retirement income, home improvements, or debt consolidation	Interest compounds over time, increasing the total debt
No monthly repayments required (for lifetime mortgages)	Early repayment can incur significant charges
Provides a lump sum or drawdown facility to supplement retirement	May reduce the amount of inheritance you can leave behind
Stay in your home for the rest of your life	Equity release plans can be complex and may affect your eligibility for certain benefits
No Negative Equity Guarantee ensures you never owe more than your home’s value	Some property types may be ineligible

Before deciding on an equity release plan, it’s crucial to seek professional advice to ensure this kind of product aligns with your financial goals and personal circumstances.

The Basics of Inheritance Tax

As part of your comprehensive estate planning and intergenerational wealth transfer strategy, it’s essential to understand the fundamentals of inheritance tax.

This often complex topic can have a significant impact on the assets you aim to pass on to your loved ones, so let’s dive into the key details.

What Is Inheritance Tax?

Inheritance tax is a tax levied on the transfer of assets, such as property, investments, and other possessions, from a deceased individual to their heirs or beneficiaries.

This tax is calculated based on the value of the estate.

Who Needs to Pay Inheritance Tax?

Inheritance Tax (IHT) is paid by the estate of the person who has died.

What to know:

• If the estate is left to a spouse, civil partner, charity, or community amateur sports club, it may be exempt from IHT.
• Beneficiaries generally do not pay IHT on the assets they inherit, but they may have related taxes to pay, such as income tax on rental income from inherited property.¹
• The executor of the will or the person dealing with the estate is responsible for arranging the payment to HM Revenue and Customs (HMRC).

How Inheritance Tax Is Calculated

IHT is charged at 40% on the value of the estate above the tax-free threshold, which is currently £325,000.²

Inheritance Tax (IHT) in the UK is calculated based on the value of the deceased person’s estate.

Here are the key steps:

1. Determine the Estate’s Value: Calculate the total value of the deceased’s assets, including property, money, and possessions. Deduct any debts and liabilities.
2. Apply the Tax-Free Threshold: The standard tax-free threshold is £325,000. If the estate’s value is below this threshold, no IHT is due. If the estate is left to a spouse, civil partner, charity, or community amateur sports club, it may be exempt from IHT.
3. Calculate the Taxable Amount: Subtract the tax-free threshold from the total estate value to determine the taxable amount.
4. Apply the Tax Rate: The standard IHT rate is 40%. This rate is applied to the taxable amount. For example, if the estate is worth £500,000 and the tax-free threshold is £325,000, the taxable amount is £175,000, and the IHT would be 40% of £175,000.
5. Consider Reliefs and Exemptions: Certain reliefs, such as Business Relief, may reduce the IHT bill.³ Additionally, if 10% or more of the estate is left to charity, the IHT rate may be reduced to 36%.⁴

How Equity Release Affects Inheritance Tax

Equity release can affect inheritance tax (IHT) in several ways.

By releasing equity from your home, you reduce the value of your estate, which may lower the amount of IHT payable upon your death.

If the equity released is spent rather than invested, it can further reduce the estate’s value, potentially bringing it below the IHT threshold.⁵

However, it’s important to consider the long-term impact on your estate and future beneficiaries.

Consulting a financial adviser can help you understand the implications and make informed decisions.

The 7-Year Rule

The 7-year rule refers to the period within which gifts made during your lifetime may be subject to Inheritance Tax (IHT).

If you release equity from your home and use the funds to make gifts, these gifts could be considered part of your estate for IHT purposes if you pass away within seven years of making the gift.

However, after seven years, gifts are typically exempt from IHT, under the “7-year rule”.

It’s important to factor this into your tax planning when using equity release to avoid unexpected tax liabilities.

Always seek professional advice for clarity.

Equity Release and Trusts

Using trusts in conjunction with equity release can offer several advantages, particularly in managing funds and potentially reducing tax liabilities.

Here are some key points to consider:

• Placing equity release funds into a trust can help protect these assets from creditors and ensure they are used according to your wishes.
• Trusts can provide tax benefits by potentially reducing inheritance tax (IHT) liabilities. By placing funds into a trust, you may be able to remove them from your estate, thereby lowering the overall value subject to IHT.
• Trusts offer a high degree of control over how and when the funds are distributed. You can set specific conditions for the use of the funds, such as education, healthcare, or other needs of beneficiaries. This ensures that the money is used in a manner that aligns with your intentions.

By using trusts to manage equity release funds, you can achieve greater control, protection, and potential tax benefits, ensuring that your financial planning aligns with your long-term goals and the needs of your beneficiaries.

Setting up a trust can be complex, and it’s crucial to work with a qualified solicitor or financial adviser who specialises in trusts and estate planning.

They can help you navigate the legal and tax considerations, ensuring that the trust is structured correctly and meets your goals.

Common Questions

In Short: Equity Release as an Inheritance Tax Tool

Equity release can be a valuable tool for accessing funds in retirement, but it also has significant implications for inheritance tax.

By reducing the value of your estate, equity release may lower the amount of inheritance tax payable.

However, it’s essential to consider the full long-term impact on your estate and beneficiaries, so speak to a qualified advisor.

Understanding the relationship between equity release and inheritance tax is crucial for effective estate planning.