Equity release and inheritance tax: what you need to know

What is equity release?

Equity release allows you to unlock the value of your home without the hassle of moving. 

It could be a great way to pass on wealth early, helping your loved ones with money they need for a house deposit or other essential costs. 

The most common type of equity release is a lifetime mortgage, where the lender pays you a lump sum upfront (or smaller lump sums), which is secured against your home. You won’t have to repay the loan during your lifetime.

Instead, interest is rolled up and repaid on your death or if you move into care and your home is sold. Read our article about the different types of equity release and how they work.

How can equity release reduce your inheritance tax bill?

Equity release could help you pay less inheritance tax (IHT) by freeing up cash to pass on wealth early to your loved ones. Gifts made more than seven years before your death won’t be counted as part of your estate for IHT, potentially slashing your tax bill.

Here is an example of how it could work in practice.

Mrs Jones is a widow and has already inherited wealth from her husband. She owns a home worth £1.9 million and wants to help her three children with a house deposit. She has a small final salary pension and £100,000 in savings and can’t afford to give substantial gifts.

As it currently stands, their children could face a large IHT bill of £400,000 on her death.

She takes out an interest-only lifetime mortgage of £600,000 to help her children get on the housing ladder and gives three gifts of £200,000 each. Her children agree to pay the loan interest, so there is no extra interest to pay on her death.

She dies after 10 years, and her estate is worth £1.4 million. There are £1 million tax allowances available, leaving a reduced IHT bill of £160,000 to pay.

Will I owe inheritance tax on my home?

While equity release can be a great way to save on IHT, it may not be right for everyone, especially because not everyone will have to pay inheritance tax.

Single homeowners who have less than £500,000 in assets may not have to pay IHT at all, while married couples can often pass on up to £1 million tax-free. Any assets over the available allowances will attract inheritance tax of 40%.

Everyone has a £325,000 ‘nil-rate band’ and homeowners passing their home to descendants enjoy an extra £175,000 ‘residence nil-rate.’ Meanwhile, married homeowners with children can combine allowances to pass on up to £1 million tax-free.

Here, it’s vital to get tax advice and have a will in place to make sure you use all available allowances. Read more here about the detailed IHT rules.

Inheritance tax on gifts from equity release

Financial gifts made more than seven years before your death won’t be counted as part of your estate for inheritance tax, including any gifts made using equity release.

However, if you die within seven years, there could still be tax to pay on the gift. It will be counted as part of your estate when calculating any IHT due. Any tax due is paid from your estate when you die.

If you give away more than £325,000 before you die, the tapering rules mean that any tax due on the gift could be reduced if you die between three and seven years after giving the gift.

Pros of using equity release to make gifts

Here are the main pros of using equity release to make gifts to your loved ones:

• Allows you to pass on wealth early without moving house.

• You could potentially save on inheritance tax as long as you live for seven years.

• There are lots of features available that allow you to downsize or port a loan to a new property.

• Regulated loans have a no negative equity guarantee.

Cons of using equity release to make gifts

While equity release could free up funds to pass on wealth early, it also comes with some downsides, including the following:

• Higher interest rates than a standard mortgage.

• Less money to pass on to your loved ones.

• Potentially more expensive than downsizing.

• Inheritance tax could still be payable if you die within seven years of making a gift.

What happens if you inherit a house with equity release?

If you inherit a house with an equity release loan, the loan usually becomes payable within 12 months. The executor will repay the loan with other money available in the estate as part of the probate process.

You have a few options here:

• Sell the house and use the proceeds to pay off the loan.

• Keep the house and arrange a new mortgage to pay off the loan.

• Use other funds in the estate or from your own money to pay off the loan.

What happens if there is negative equity?

All UK equity release plans regulated by the Equity Release Council (ERC) include a ‘no negative equity guarantee,’ so the debt won’t be passed on if the house is worth less than the loan amount.

It’s essential to check that your scheme is ERC-approved, as you will benefit from consumer protections.

What features should I look for?

There are plenty of options if you’re considering equity release.

Here are some features to look for:

• Reserve facility: This allows you to access further funds in the future, which could be useful if you want to stagger payments to your loved ones.

• No negative equity guarantee: This guarantees that the debt is capped at the value of your home.

• Porting: This lets you transfer the loan to a new property if you decide to move in the future.

• Downsizing protection: This allows you to repay the loan with no penalties if you need to move to a smaller home.

Considering whether equity release is right for you? 

Here is more information on whether equity release is a good idea. Our article on if you can pay back equity release might also prove to be useful, too.

Equity release could be a great way to help out your loved ones, while also saving on future inheritance tax. But it’s a huge decision and needs to be weighed up carefully. It’s vital to understand the different options and how they could affect your future finances.

Unbiased will match you with a qualified financial adviser or mortgage broker who can help you work out the best option to suit you and your circumstances.