Understand how equity release and inheritance tax work and how they impact your beneficiaries
Can equity release be used to relieve the impact of inheritance tax? And at what cost?
If you're thinking about equity release, it's worth thinking about the possible impact equity release and inheritance tax could have on what you leave behind to your beneficiaries – especially if your home is your biggest asset.
What is inheritance tax?
Inheritance tax is a tax paid on a person’s estate when they die. The amount owed depends on the total value of the property, money and possessions left behind:
There's no tax to pay if the value of the estate is less than the £325,000 threshold, or if everything above £325,000 is left to a spouse, civil partner or charity (2023/24 tax year).
If the value of the estate is over £325,000 and is left to family or friends, any amount over the threshold will be taxed at 40%.
Married couples or civil partners can also pass on any unused tax-free threshold to their surviving partner.
The gov.uk website has in-depth information about the ins and outs of equity release and inheritance tax.
How does equity release affect inheritance tax?
Equity release will reduce the amount of capital that is passed on to your beneficiaries when you die. When you raise money through equity release you will most commonly get a lump sum, and in a few cases regular cash payments, on the understanding that the provider is repaid when you die or move into permanent long-term care.
This usually involves selling your home to pay the equity release bill – and this means your beneficiaries won't inherit it. Your beneficiaries may be able to settle the outstanding amount from other funds and so the house might not be sold. If the house is sold, anything left over after clearing the debt is passed on to your beneficiaries.
So what steps can you take to safeguard some level of inheritance?
Different types of equity release and inheritance tax impact
With a lifetime mortgage, you borrow money through a loan which is secured against your home. The loan is usually repaid when you (or the last borrower on a joint plan), die or move into long-term care. You can choose to make adhoc payments to reduce the overall cost of the loan and with some products you can choose to repay some or all of the interest monthly.
Reputable providers should offer a ‘no negative equity’ guarantee so the total that will need to be repaid can never exceed the value of your home when it is sold following your death or entry into long-term care.
But, if you borrow through equity release over a long period, you could end up owing as much as your home is worth.
If the home sells for more that the outstanding loan amount, any remaining funds can be left to your beneficiaries and could be subject to inheritance tax, depending on the size of the estate.
Home reversion plans and inheritance tax
With a home reversion plan, you sell part or all of your home to the equity release company while retaining the right to live in it for the rest of your life.
When you (or the last borrower on a joint plan), die or move into long-term care, the company is paid out of the proceeds of the sale of your home.
By selling a share and not all of your property, you can guarantee that you'll be able to leave at least some inheritance to your beneficiaries.
The money you raise through home reversion will be less than the current market value of the property share you are selling – so if you sell a 40% share in a home worth £200,000, you will get less (often considerably less) than the £80,000 this share is currently worth. This is to reflect the fact that the provider won't get its money for many years.
Can you minimise interest bills to boost inheritance on a lifetime mortgage?
If you choose a lifetime mortgage with a ‘drawdown’ option you can release money from your home as and when you need it rather than in a single lump sum. This will affect the total amount you pay back, depending on the interest rates and the length of term left on your loan as you do this.
Interest will be charged on the amount of the loan that you drawdown, rather than on the total amount of equity that is available to you, which can help keep total loan costs under control. However, there is still no guarantee you'll be able to leave an inheritance.
Some lifetime mortgages will allow you to pay off interest monthly as you go. If you can afford it, and pay the interest off in full, you’ll owe the original capital sum that you borrowed alongside any charges, but without interest being added from the start. As a result, you’ll be more likely to be able to leave an inheritance.
Does equity release reduce inheritance tax?
You can potentially use equity release to reduce inheritance tax. If you release equity from your home and gift it to another person, this may help reduce inheritance tax:
Each tax year you can give away a total of £3,000 worth of gifts without them being added to the value of your estate. This is known as your annual exemption, which can be carried over for one tax year if you don't use it.
The amount you gift will be exempt from inheritance tax if you live for seven years after the gift, and if you don't receive any direct or indirect benefit in return.
If you do die within seven years however, the amount will be considered alongside the rest of your estate when calculating how much tax is due.
If you die between three and seven years after the gift taper relief will be applied to the tax you pay, meaning less is owed the longer you survive.
You can also make an unlimited number of gifts annually of up to £250, and a higher tax-free gift to someone who is getting married or starting a civil partnership. This varies from £1,000 to £5,000 depending on their relationship to you. You can find out more on the gov.uk inheritance tax pages.
Making lifetime gifts over £325,000 can have a negative impact on the recipient's tax status, so you should take professional advice before taking this step.
How do I decide if equity release will help reduce inheritance tax for me?
The implications for inheritance tax on equity release is one area of many that you need to carefully consider before going ahead, and you need to seek professional advice before making a decision.
The Saga Equity Release team will help you find out how equity release could help you. Saga Equity Release is provided by HUB Financial Solutions Ltd and is for those aged 55 or over with a UK home worth at least £70,000. Find out more with no-obligation advice from a specialist equity release adviser.
As part of the service, you'll have access to a UK-based qualified adviser and support team, who will advise you on your options and outline solutions tailored to your specific circumstances. Please be aware that equity release will reduce the value of your estate and may affect your entitlement to means-tested state benefits.