Equity Release for Inheritance Tax (IHT) Planning
Equity release is a type of mortgage that allows people aged 55 or over release the money that has been tied up in their home. They won’t be charged tax on this amount and will be able to spend that money on whatever they want.
With equity release, you do not have to repay the loan until you pass away, or alternatively move into a care home for health reasons.
Once this happens, you or your next of kin will be responsible for selling your home and using the money from this sale to repay the entire loan.
Remember, as with any type of loan, you will certainly be charged interest on your equity release loan. This means that year on year, your loan amount will increase due to compound interest.
There are two main types of equity release, including lifetime mortgages and home reversions plans, which have a number of differences.
When applying for an equity release loan, you will need to seek support and advice from an advisor and solicitor to ensure that you are putting yourself forward for the right type of equity release loan.
What is inheritance tax?
Inheritance tax is the tax on someone’s estate (including their property, their possessions and their savings) that people are charged once they pass away and pass their inheritance down to their loved ones.
What is the inheritance tax threshold?
You won’t be charged inheritance tax if your estate (including your property, your possessions and your savings) comes to less than £325,000.
If you leave your estate above the £325,000 threshold to your partner, civil partner, charity or community sports club then you also will not be charged inheritance tax [1].
Likewise, if you gift your home to your children or grandchildren, then the threshold will increase to £50,000 [1].
The standard inheritance tax rate currently sits at 40%. However, you will only have to pay 40% tax on anything that sits above the threshold, in the same way that income tax works. Below is a useful example.
If someone’s estate is worth £500,000 in total (including their property, their assets and their savings) and the tax free threshold is £325,000, then they will only be charged 40% inheritance tax on the £175,000 over the threshold amount [1].
When is Inheritance Tax due?
Inheritance tax is due within 6 months after the individual passes away. HMRC will charge you interest if you do not pay the full amount of inheritance tax by the six month due date.
Whoever is in charge of your estate (whoever is named as the executor) is responsible for ensuring that the inheritance tax is paid off in full and on time. It is important to appoint someone responsible and trusted enough to do this in your Will, before you pass away.
It is important to remember that if you have a partner, a husband or wife or civil partner then you can leave your estate to your partner. This means that any unused allowance can go to your loved ones and you will not be charged.
Lifetime mortgages (a type of equity release) and inheritance tax
Lifetime mortgages allow you to release a tax-free amount of money from your home, free for you to spend on whatever you want. You do not have to repay the loan until you pass away.
When it comes to inheritance tax and lifetime mortgages, it is important to consider the fact that the money that goes to your loved ones might be subject to inheritance tax, should the property sell for more than the loan amount.
In this case, any remaining proceeds would go to your loved ones as inheritance, which might be subject to inheritance tax should it be over a threshold amount.
Opting for a drawdown option, rather than a lump sum will affect how much you pay back, as the amount of compound interest you are charged will be affected.
Home reversion plans and inheritance tax
With home reversion plans, you have to sell a set percentage of your home to the lender in order to receive your equity release funds.
By selling a smaller percentage of your home to the lender, you will be able to guarantee that you can leave some form of inheritance to your loved ones.
Remember, by gifting your money away to your family whilst you are still alive, that amount of money will not be subject to inheritance tax. Anything that goes to your next of kin as inheritance after you pass might be subject to inheritance tax.
However, it is important to remember that by opting for a home reversion plan and selling part of your home to the lender, you will be selling for less than the market value.
This means that you might not receive as much money from your home reversion plan as you would have hoped for.
How can equity release reduce your inheritance tax bill?
Taking out an equity release loan might help you to lower your inheritance tax liability. Your inheritance tax will be calculated on your entire estate, including your property and other assets including your possessions.
The great thing about taking out an equity release loan is that equity release is a loan, which needs to be repaid upon death, meaning that it is named as a liability.
This means that it will be deducted from your total assets, therefore reducing the overall value of your estate and how much inheritance tax you will have to pay.
However, it is important to remember that whilst your inheritance tax bill might be reduced, you will still have to repay your equity release loan once you pass away. In order to do so, the property will most likely need to be sold.
If you are considering taking out an equity release loan in order to reduce the amount of inheritance tax you will have to pay on your estate, then your equity release solicitor and lawyer might want to work closely with your tax planner to ensure that you are making the right and most financially savvy decision for you.
If you are looking to use equity release for inheritance tax planning, then you are able to gift your equity release money to your loved ones as a form of early inheritance.
This way, they get to spend their inheritance early and you are alive to watch them put the money to good use and enjoy it.
It is important to do this early on, as the money that you gift away to your loved ones from your equity release loan as early inheritance could be subject to inheritance tax if you pass away within just 7 years of gifting the money.
If you live for 7 years or more after gifting the money, then you will not need to pay any inheritance tax on this amount.
How does inheritance tax affect gifting money to family?
If you are planning on using your equity release funds to gift money to your family and reduce your inheritance tax bill, then there are a few rules that you will need to follow, otherwise the money that you gift will be affected.
For example, if you pass away within 7 years of gifting your money to your loved ones, then you might be charged money on this.
If you pass away within 7 years of gifting your money, then you might be charged tax depending on who you gift the money to, how much you gifted away to them and when it was given [2].
If you wish to gift your equity release money to your loved ones, then it is important to make your equity release advisor and solicitor aware of this plan before taking out an equity release loan, as this will have a major impact on how much you release and which type of plan you should apply for.
How much money can you gift to your family tax-free?
Each year, you are able to gift some of your money and assets to your family and loved ones, without being charged inheritance tax. How much tax free allowance you have depends on which allowances you opt for.
You are able to qualify for an annual exemption. This means that you are able to give away at least £3,000 worth of gifts each year, without it being added to the total value of your estate.
This amount is known as your ‘annual exemption’ when it comes to inheritance tax. You can either give your money to one person, or a number of people.
What can you gift to your family as an inheritance?
There are a number of things that you are able to gift to your family as inheritance. This includes things such as money, household items and goods, furniture, jewellery, antiques and properties. If you have any land or buildings then this will also be included as a gift.
Likewise, you are also permitted to give your family or friends wedding gifts. If you want to avoid paying inheritance tax by gifting your assets as a wedding gift, then you will have to give the newlyweds before the wedding, not after.
The money has to be worth less than £5,000 if it is going to a child, and less than £2,500 if it’s going to a grandchild or great grandchild. If the money is going to another relative or friend, then it needs to be less than £1,000.
You are also permitted to gift away any stocks or shares that you might have that are currently listed on the London Stock Exchange.
It is important to remember that a gift needs to be something that you give away whilst you are still alive.
Anything that you leave in your Will will not count as a gift, as this will be counted as inheritance.
So, if you plan on leaving inheritance to your loved ones as see this as a ‘gift,’ remember that this will be classed as inheritance and this will be subject to inheritance tax if it sits about the inheritance tax threshold.
Keep records of anything gifts you have given
If you are planning on gifting some of your assets to your loved ones as a way of avoiding inheritance tax, then it is important to keep a record of all the gifts that you have given away over time.
Not only is it easy to forget what you gave and to whom, it is also important to have a record of what you have gifted away, so that you can prove this when it comes to HMRC.
Likewise, the individual who has to deal with your estate after you pass away (usually the executor of your Will and your next of kin) will have to work out what gifts you gave to who, in the 7 years leading up to your death.
This is why it is important to keep clear records that would easily be found should you pass away unexpectedly.
If you are planning on gifting your money to your loved ones as a way of avoiding paying inheritance tax on your estate, then you should keep records of the following things:
- Exactly who you gave the money to
- When you gave each person money (exact dates are always helpful)
- The exact value of the gift (including any money, possessions or assets)
If you are confused about what counts as a gift, or need help remembering exactly what you gave to who and when, then speak to an adviser and solicitor for advice and support.
What is inheritance protection when it comes to equity release?
Inheritance protection is an optional extra, part of any equity release scheme across the UK. Inheritance protection allows you the chance to set aside a part of your inheritance for your loved ones and next of kin.
They will receive this money no matter what happens, once you pass away and the equity release loan is repaid.
Unfortunately, many people believe that opting for an equity release loan means that you will not be able to leave inheritance for your loved ones, although this is simply not the case.
Naturally, opting for an equity release loan might mean that your loved one(s) receive less inheritance, as your home will need to be sold in order to pay off the equity release loan.
However, with inheritance protection, a set amount of your wealth and inheritance will be set aside, so that you can guarantee this amount will go to your loved ones as inheritance, no matter what happens with the value of your home or the equity release scheme.
Likewise, your equity release loan will include a no negative equity guarantee, which will protect your loved ones and their wealth.
The no negative equity guarantee ensures that even if your home decreases in value, and no longer pays off the loan amount, then your loved ones won’t have to pay the difference or shortcomings. Instead, the lender will pay off the difference.
The disadvantages of using equity release
At Equity Release Warehouse, we are well aware that as with any type of loan, there are a number of drawbacks when it comes to equity release.
Whilst there are some drawbacks to equity release, there are also a lot of myths surrounding equity release, and it is important to know the difference. Some of these differences are explained further below [3].
1. Less inheritance for your loved ones
As mentioned above, if you opt for an equity release loan then you are likely to leave less inheritance to your loved ones. This is because once you pass away, your house has to be sold to pay off the initial loan, plus any added interest.
2. You will be charged interest
Likewise, you will be charged interest on your equity release loan. You will either be charged interest on a weekly, monthly or yearly basis and this will continue until you pass away or move into a care home, once your loan finishes.
The interest rate will be fixed, meaning that you will know exactly how much you are going to pay in interest from the very start. However, it is important to remember that your interest will compound year on year, meaning that the amount of money you owe will snowball and grow.
3. Your benefits entitlement might be affected
If you take out an equity release loan, then your entitlement to your benefits might be affected. This is only the case for any means tested benefits you currently receive or are due to receive in the future.
Unfortunately, this includes things such as pension credit, council tax reduction, child tax benefit, income support or job seekers allowance.
Is equity release safe?
At Equity Release Warehouse, we accept that there are clearly drawbacks to taking out an equity release loan, as explained above.
Nevertheless, the industry is now well regulated and authorised by a number of bodies, including the Financial Conduct Authority and the Equity Release Council.
All equity release advisers and lenders must be authorised by the Financial Conduct Authority (FCA).
This means that all advisers working in the equity release industry must be qualified to do so and must at all times follow all rules set out by the Financial Conduct Authority.
The Equity Release Council is the equity release industries trade body, which sets standards and frameworks for all those who work in the equity release industry to follow.
All equity release providers and lenders must abide by the industry standards and only ever offer products which are fair, honest and in the best interests of the client.
Luckily, with help from the Financial Conduct Authority and Equity Release Council, the industry is now more regulated and safe than ever.
Naturally, with any type of industry, it is always important to be aware of any scammers or fraudsters operating within the industry [4].
References
[1] https://www.gov.uk/inheritance-tax
[3] https://nationaldebtline.org/fact-sheet-library/equity-release-ew/
