Do you pay tax on equity release?

Summary

• Equity release is a loan, not a form of income, so you do not pay capital gains or income tax on it.

• Equity release can reduce your inheritance tax (IHT) bill and help your pension, as you can use it to partially fund your retirement.

• While releasing equity is not taxable, it will reduce your estate’s value, and you will incur various costs and potentially high interest.

• It is worth speaking to a mortgage broker or financial adviser to get guidance about equity release and how to use it to your advantage. 

What are the tax implications of equity release?

Releasing equity in an asset such as your home can be tempting, whether you want to access cash to supplement your income or for other purposes.

If you’re considering this, you’re probably also wondering about the tax implications of equity release. 

The simple answer is that you do not need to pay direct tax on the money you receive from equity release.

That said, if you’re thinking about releasing equity, there is more to consider. We take a closer look at equity release and inheritance tax (IHT), as well as other potential implications. 

Why is equity release not taxed?

There is no tax on equity release because it essentially is a loan.

This means the money you receive from equity release is exempt from taxes you must pay when you gain money through regular income, interest on savings, or other means. 

The two types of taxes usually discussed are capital gains and income tax. While you won’t need to pay either on an equity release, it’s important to remember that releasing equity will reduce your estate’s value, and you will incur various costs and potentially high interest.

Capital gains tax

You do not need to pay capital gains tax on equity release. 

Capital gains tax is the tax you must pay on the profit you make when you sell an asset that has increased in value.

This type of tax is usually associated with large assets such as properties. However, due to the Private Residence Relief, there’s a full exemption from paying capital gains tax on the profit you make if you sell your primary residence property.

Income tax

There’s also no need to pay income tax on equity release. Even though you receive money when releasing equity, it’s not regarded as a form of income as it’s a loan. 

It’s possible to add a reserve facility as an additional feature to your equity release plan. 

When combined with this feature, these plans are known as drawdown plans. If you have one of these plans, you can release money from your property in stages.

You can keep the money you don’t need immediately in the reserve facility, which is non-interest-bearing.

You won’t be charged interest on the money in the drawdown plan until you withdraw it. 

Bear in mind that if you invest the money from your equity release, such as putting it in a savings account, the interest you earn on it could be subject to tax. 

How can equity release reduce inheritance tax?

Many people in the UK worry about equity release and IHT. The good news is that an equity release plan can help reduce this tax burden. 

What is inheritance tax, and how does it work?

IHT is a tax on the estate, including property, money, and possessions, of someone who has died.

However, you normally do not pay this tax if your estate value is below the value of £325,000 or if you leave everything above the threshold to your spouse, civil partner, a community amateur sports club, or a charity.

The standard IHT rate is 40% and is only charged on part of the estate above the threshold.

How can equity release help your IHT liability?

An important aspect of equity release and inheritance tax is how it can help reduce your tax bill.

Your estate is calculated using the value of all your assets minus any liabilities.

Releasing equity from your estate lowers your estate’s value, reducing any IHT that can be applied. 

Let’s say, for example, your total estate is worth £700,000. Subtracting the £325,000 threshold, £375,000 is left and subject to IHT at 40%.

The total IHT you need to pay is £150,000, but equity release can reduce this. 

Let’s say you have a £300,000 equity release. This reduces your estate to £400,000 (£700,000-£300,000). Less the £325,000 threshold leaves £75,000 subject to the 40% IHT, which makes the total amount of IHT to be paid £30,000.

What about early inheritance and gifts?

If you plan on giving an early inheritance or gifts, you might be concerned about the tax implications of equity release.

These gifts can be subject to IHT. However, if you live for at least seven years after making the gift, there will be no IHT.

There’s a sliding scale known as taper relief for gifts made less than seven years before death.

How can equity release be used to help your pension?

While money withdrawn from private pension funds is subject to income tax above the tax-free allowance, your pension isn’t part of your taxable estate.

This means you can bequeath it to your beneficiaries without paying IHT.

The question is how to support yourself if you want to keep part of your pension for your beneficiaries, and the answer is to use equity release to partially fund your retirement.

This also allows your pension pot to grow for longer, but you also could incur a lot of interest.

Most modern pension schemes allow you to pass on your pension tax-free if you die before age 75.

If you pass away after this age, your beneficiaries must pay income tax on anything they withdraw from your pension pot. 

The money you withdraw from your pension fund becomes part of your estate. If your total estate value exceeds the tax-free allowance, this will be subject to tax.

Using equity release money before withdrawing from your pension fund means it can be passed down separately from your estate, and the overall IHT owed after your death is reduced (if you die before 75). 

Seek expert financial advice

As you can see, equity release can impact the total value of your estate, and as it is a loan, you may incur interest.

That said, equity release can reduce your inheritance tax and help your pension. 

Get matched with a mortgage broker through Unbiased for help with equity release and planning effectively for the future.