Using equity release to reduce inheritance tax

You’ve built up your estate’s value for many years to ensure that your loved ones are looked after financially when you die. But what are the implications with inheritance tax and can you use equity release to reduce the amount payable? Here, we’ll explain how inheritance tax is applied, how equity release can be used to reduce the tax liability and whether equity release is a good option for mitigating inheritance tax.

What is inheritance tax?

Inheritance tax is the tax payable on your estate to the government in the event of your death. As an individual, it’s payable on assets worth over £325,000. This means your beneficiaries can receive £325,000 without any tax being due. This amount is called the nil-rate band because no inheritance tax is due under this threshold. On any amount in excess of this threshold, however, 40% inheritance tax is charged.

The nil-rate band doesn’t apply if you pass your estate to your spouse or civil partner, though. In this case, the estate is exempt from inheritance tax. Your partner also benefits from any of the unused allowance. Therefore, as a married couple, you can pass on a tax-free sum of £650,000 to your beneficiaries.

When passing your main residence on to a direct descendant, there’s an additional nil-rate band of £175,000. This means you can pass on an estate that includes your main residence to a direct descendant up to an amount of £500,000 without any inheritance tax being payable. Any of this nil-rate band that’s unused can also be transferred to your surviving spouse or civil partner so the nil-rate band passed on by a married couple is £1 million.

How can equity release reduce inheritance tax?

Equity release allows you to utilise funds that are tied up in your property. You can take out a lifetime mortgage or a home reversion plan and use the cash however you want to. This could be to enjoy a more comfortable retirement, to carry out home renovations or maybe to lend a helping hand to a relative. Whichever form of equity release you choose, your home is sold when you move into long-term care or die and the debt is repaid from the proceeds of the sale.

By releasing some of your home’s equity, you are reducing the value of your estate. By doing this, you reduce the amount of inheritance tax payable on your estate. This might even bring your estate’s value under the inheritance tax threshold. Your estate includes any funds you have in the bank so you need to spend any equity you have released. Otherwise, inheritance tax will be charged at 40% over the threshold.

Gifting money

You can use your released equity to gift money to your children. As long as you are still alive for 7 years after you have gifted the money, no inheritance tax will be due on it. This is a great way for your beneficiaries to receive an early inheritance and for you to see it put to use while you’re still alive. It could go towards a wedding or a deposit on a house in Bexley or Bexleyheath, for example. If you should die within the 7 years after you’ve gifted the money, however, the amount you gifted will be included as part of your estate.

Is equity release a good choice for inheritance tax mitigation?

As already mentioned, equity release reduces the value of your estate and, therefore, helps minimise the inheritance tax liability. When choosing a lifetime mortgage for equity release, the loan is likely to have compounded interest and the final debt owed may be quite substantial. As a liability, it is deducted from your estate’s value before the inheritance tax is calculated. In both capacities, equity release is an effective way to reduce the inheritance tax bill.

There are many other options available and equity release shouldn’t be your only choice to mitigate inheritance tax. Speak with your financial adviser first for specialist advice that’s tailored to your situation.