With equity release, the cash lump sum of money is completely tax-free and without any need for monthly repayments! You can use the tax exemption as part of more comprehensive financial planning, or for you to enjoy the use of your money that's tied up in your property.
In this guide, you will learn:
There are two main types of tax that people discuss with me when they are looking into equity release plans; Income tax, and Capital Gains Tax. For both of these types of tax, any Equity Release will not have any impact.
Let's look at these types of tax in greater detail.
Income Tax
Equity Release is exempt from Income Tax as it's not a form of income; it's a loan, just like a residential mortgage.
Even if you are planning to use Equity Release to top up your income, you are not subject to any taxation.
An additional feature which people often add to equity release plans is a reserve facility. Equity Release plans with reserve facilities are commonly referred to as draw-down plans.
A draw-down plan allows you to release money from your property in stages, as and when you need the funds. The reserve facility holds money which you don't need right away and is non-interest bearing. You can think of it a bit like a savings account. You can withdraw money from it as and when you need it, typically in a minimum £2,000 tranches.
You aren't charged interest for the amount in the draw-down until you withdraw the funds. So they can be great for when you aren't looking to spend all the money in the short term, but planning on needing it in the future.
Although the funds released are free of income tax, if you invest the money, for example into a savings account, any interest could be subject to tax.
Capital Gains Tax (CGT)
CGT is a tax that is often associated with properties, as they are often high-value assets. CGT is a tax on the profit when you sell an asset that's increased in value.
We have seen property value increase drastically over the recent years, and as a result, you can make significant profits compared to the amount you first paid.
As your property is an asset, you may think that CGT would be charged if you sold your home. However, there is a full exemption on your primary residence property, called 'Private Residence Relief'.
Equity Release plans have no impact on the value of the property and are therefore exempt from any CGT liabilities.
If you are worried about paying Inheritance Tax, an Equity Release plan could be used to help lower the burden.
Let's first look at what Inheritance Tax is, and then how Equity Release can be used effectively to reduce any potential liability.
What is Inheritance Tax?
Inheritance Tax is a tax on the estate of someone who has passed away. Not everyone pays it, and the current threshold for an individual is £325,000. So if your estate is worth less than this, you would not pay any IHT.
Are there other reasons why IHT would not be paid?
Yes. One of the most common reasons that IHT is not paid is if everything above the threshold was left to a spouse, civil partner, a charity or a community amateur sports club. If this is the case, the allowance can be transferred from one person to another, effectively doubling their allocation from £325,000 to £650,000.
In some cases, the threshold for IHT can be increased. If you choose to 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. For married couples or civil partnerships, any amount that's unused in the threshold can be transferred and added to the partner's threshold. In total it is possible to create a maximum limit of £950,000 for the estate which is free from IHT.
Currently, the standard Inheritance Tax rate is 40% and is only charged on any part of the estate above the threshold, whatever that may be.
Remember: IHT is levied on the total value of your estate, including all assets, investments, and cash held.
Now how can Equity Release help with Inheritance Tax?
Your estate is calculated from the worth of all your assets minus any liabilities you may have. Releasing money from your estate lowers your estate's value, therefore reducing any IHT that could be applied.
Equity Release is one of the very few ways to release money tied up in your home that would naturally contribute towards your estate and IHT.
Remember: You can spend this money on anything you want. As long as you aren't solely buying other assets to add to your estate value, your IHT liability will be reduced.
IHT Example: No Equity Release
Your property is worth £500,000, and you have £200,000 in investments, savings, and other assets (including your car and furniture). Therefore your total estate is worth £700,000 (including your property). You also have no existing mortgages.
Estate worth £700,000 minus the threshold of £325,000 = £375,000.
Inheritance Tax is at a rate of 40%.
Total IHT to be paid: £150,000.
Now let's look at how equity release can reduce your IHT liability.
We will use the same example as above. If you had a lifetime mortgage of £267,000 on that property, and after five years at an interest rate of 4.00% meant you owed just under £325,000. This amount would be taken away from your estates worth. You would only need to pay £30,000 Inheritance Tax, compared to £150,000. Again, let's have a look at how we got there.
IHT Example: With Equity Release
Estate (£700,000) - £300,000 Equtiy Release = £400,000
Less the basic threshold.
£400,000 - £325,000 = £75,000.
Inheritance Tax is at a rate of 40%.
Total IHT to be paid: £30,000.
In this example, we saved £120,000 of Inheritance Tax liability.
Gifts
A common use for Equity Release is to gift an early inheritance to loved ones. Not only does this allow you to see your loved ones enjoy the use of this money before you pass, but it's lowering your estate's value. In turn, having a lower-valued estate could reduce your IHT.
Gifting can be subject to IHT; however, if you live for seven years after the gift was made, there's no IHT to pay at all. Gifts made within seven years of death have rules on how much IHT can be charged. This works on a sliding scale known as 'taper relief' which is shown below.
| Years between gift and death |
Tax payable |
| Less than 3 |
40% |
| 3 to 4 |
32% |
| 4 to 5 |
24% |
| 5 to 6 |
16% |
| 6 to 7 |
8% |
| 7 or more |
0% |
You might be aware that your pension is not part of your taxable estate. As you can pass this down to your beneficiaries and be free of IHT on it, many people find it's a very tax-efficient way for estate planning. You could decide to use Equity Release to fund your retirement instead of relying entirely on your pension. Not only does this mean you can pass your pension on to your beneficiaries free of IHT, but it also allows it to grow longer and hopefully larger.
You should seek professional pension and tax advice if you are looking to use Equity Release as part of your estate and tax planning. We are more than happy to work alongside your advisors to get the best outcome for you.
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 tax 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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