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Everything You Must Know About Equity Release Taxes

An increasing number of older homeowners are inquiring about equity release schemes to unlock wealth from their homes. Still, many are also asking the question, “do I pay tax on equity release”? 

Equity release allows asset-rich homeowners to unlock wealth from their property in a large lump sum or smaller amounts over time. While there are no tax implications, homeowners will still have to pay interest on the released equity.  

What’s Equity Release?

Equity release is a type of remortgaging allowing homeowners over 55 to unlock equity from their homes as a tax-free lump-sum of cash. It’s a great aid in putting away money for retirement or to buy another home.

Simply put…

There are lifetime mortgages with a min age requirement of 55. This mortgage is repaid when the homeowner dies, needs medical care permanently or when the house gets sold. Lifetime mortgages have fixed interest rates, and you don’t have to make regular repayments. You can choose to repay the mortgage at the end of the term plus any rolled-up interest.

Let me tell you:

You need to look for lenders who are members of the ERC and who have a no-negative-equity guarantee. This will safeguard you against owing more than the value of your house if property prices drop.

Secondly, there are home reversion plans you could consider, with a min age requirement of 65. With these plans, you sell part of your property or the whole property at a lower rate than its market value. You’ll be able to continue living in your property rent-free, of course.

Better yet:

Your provider will repay your loan after you die and they’ve sold the house. However, it’s important to remember that by taking out money from your home, the value of your estate can be reduced and your entitlement to means-tested benefits as well.

Please seek professional help and equity release advice before doing anything.

Why Isn’t Equity Release Taxed?

Income tax and Capital gains tax are the two primary type of tax that people like to discuss. Luckily equity release has no impact on either of these.

Now let’s get savvy.

  1. Income Tax

Do you know how your residential mortgage is exempt from income tax? Well, guess what. So is equity release. The same goes for any loan because it’s not a form of income. Even if your goal with the released equity is to top up your payment, you won’t be taxed.

Better yet:

Many people add a reserve facility to their equity plan as an extra feature. These plans are then referred to as drawdown equity release plans. They allow you to release cash from your home is sections/stages as you need the money.

That’s where the reserve facility comes in. It holds your money that you don’t need right away and releases it when you need it. It’s also not charges interest.

Simply put:

It’s a kind of savings account if you will. You can keep your money safe and withdraw how much you need whenever you need it, a minimum of £2,000. Another great thing with this kind of plan is that you won’t be charged interest on the money until you withdraw it. It’s great when you don’t want to spend all your money in one go, but you might need the funds in the future.

Let me tell you something else:

Even though the money you release is income tax-free, you’ll still be charged tax on the interest if you decide to invest that money into a savings account.

  1. Capital Gains Tax (or CGT)

CGT is a tax that’s often associated with homes due to homes being high-value assets. CGY is a tax on any profit you make by selling an asset that increased in value. And, in recent years, there’s been an increase in property value. Many people are making a significant profit when selling their properties nowadays.

You might be wondering…

If your property is an asset, shouldn’t you be charged CGT1 if you sell that asset? The answer is no. Thanks to the Private Residence Relief, there’s a total exemption if the property is your primary residence.

Best of all:

You can get equity release on your second or buy-to-let properties as well, as you might know. And, the good news is that you’re also exempt from Capital Gains Tax, even if it’s not your primary residence or property.

But how?!

Well, because CGT is only charged on the property’s disposal, like if you decide to sell it. Better yet, equity release plans don’t affect your property’s value. So, it won’t fall under CGT liabilities.

How Can Equity Release Be Used To Decrease Inheritance Tax (IHT)?

Alright, you don’t have to be worried about paying inheritance tax. If you have an equity release plan, you could be paying less. But, what’s inheritance tax? And how can you use equity release to reduce its potential liability?

Let’s find out.

Inheritance Tax

Inheritance tax is a tax on the property of someone who’d died. Some people don’t pay this tax, the current threshold being £325,000. Meaning, if your estate or property is valued less than that amount, you won’t have to pay inheritance tax (IHT).

Other Reasons Why IHT Wouldn’t Have to Be Paid

  • One of the most common reasons is that the threshold was left to a spouse, partner, charity or a sports club. In those cases, IHT2 won’t have to be paid on that amount. Here, the allowance can be handed over from one person to another, double their allocation to £650,000.
  • If you leave your inheritance to your children, stepchildren or even grandchildren, the IHT threshold can be decreased to £475,000. This process is known as the Residence Nil Rate Band, established in April 2017.
  • Any unused amount in the threshold can be added to the other person’s threshold for married couples or partnerships. So, it’s possible to create a max limit of £950,000, for example, which would then also be IHT-free.

Currently, the standard IHT rate is 40%, which is only charged on any amount succeeding the estate’s threshold.

But remember:

Inheritance tax only gets levied on the total estate value, including all assets, cash and investments.

How Can Equity Release Help With IHT (Inheritance Tax)?

Your estate value is calculated using the worth of all your assets and subtracting liabilities from that value. If you release money from your estate, its value decreases, and with that, any IHT can be applied.

Listen here:

Equity release is a great way to release funds or cash that’s tied up in your home. The money or funds would typically add to your estate and inheritance tax. There aren’t many other ways to do this.

Once again:

You can use the money for anything. There are no rules! Just don’t buy more assets to add to your estate value as this will increase your IHT liability.

IHT Example: Without Equity Release

Let’s say your property value is £500,000, and your investments, savings, and assets add up to £200,000. The total value of your estate is £700,000, which includes your home. Let’s say you also don’t have any active mortgages.

Estate Worth ThresholdTotal
£700,000 £325,000£375,000
inheritance tax40%
total payable iht £150,000

How Can Equity Release Reduce Your IHT Liability?

Using the same example as mentioned above, we’ll work out how equity release can reduce your Inheritance Tax liability.

Now:

Let’s say your lifetime mortgage is £267,000 on your house, and you owed £325,000 four years ago at an interest rate of 4%. That amount will be subtracted from your property value. So, you’ll only have to pay £30,000 Inheritance Tax, instead of £150,000. How did that work?

IHT Example: With Equity Release

Estate (£700,000) – £300,000 Equity Release = £400,000

Less the primary threshold.

£400,000 – = £75,000.

Estate value thresholdequity releaseTotal
£700,000£325,000£300,000£325,000
inheritance tax40%
total payable iht £30,000
total amount saved£120,000

Let’s look at another way people use equity release.

Gifts

Generally, people like to use their equity they unlocked as a gift or early inheritance for their loved ones or family. That way, they get to see their loved ones enjoy their gift. However, this means that your estate value decreases. The effect of this is a lowered IHT as well.

But listen up:

This form of monetary gifting can be charged IHT. There’s a catch. If you’re still alive seven years after making that donation, you won’t be charged any IHT! Monetary gifts given within seven years of passing are subject to rules regarding the amount of IHT charged.

How does this work?

Well, it works according to a sliding scale or taper relief:

Years between gift & deathTax payable
Less than 340%
3 to 432%
4 to 524%
5 to 616%
6 to 78%
Seven or more0%

Can Equity Release Be Used To Help Your Pension?

The short answer is yes. Let’s dive a little deeper.

As you may or may not know, your pension doesn’t form part of your taxable estate. You can give this to your beneficiaries without being charged IHT. So, many people see this as a tax-efficient way to plan for the future of your estate.

Now:

It’s your choice if you’d like to use equity release to pay for your retirement rather than relying on your pension. This means that you can give your retirement to your beneficiaries without being charged IHT, plus you’ll see it grow!

But let me tell you:

It’s always better to discuss this matter with a professional financial adviser. They’ll discuss the full benefits and risks regarding equity release. They can also give you a personalised example.

Now, let’s recap.

Do I Have To Pay Tax On Equity I Release?

Any and all money received from releasing equity, also known as a lifetime mortgage or home reversion, shouldn’t be taxed according to law. The only thing you’ll need to think about and calculate is the interest that it’ll accrue or accumulate when you put that money into a savings account.

Simply put:

If you took out a considerable amount of money that you want to put into a savings account, you’d need to make sure about the interest and whether or not it’ll exceed your PSA (or personal savings allowance.) Exceeding this allowance will mean paying tax on any excess amount according to the usual income tax rate.

You have to remember:

Once you reach that PSA limit, the remainder of your savings can be protected from being taxed up to the max ISA allowance. Interest that’s earned after that time will be taxed.

Let me tell you something else:

Financial advisers won’t tell you to release considerable amounts of money using equity release and put it into a savings account. Why not? It’s because the monetary value you remove using a lifetime mortgage is the difference in interest costs versus interest earned in savings.

Releasing your equity in one lump-sum will mean accrued interest costs on you. This is at a higher rate than what you’ll earn in the savings account. Maybe consider taking out a drawdown plan which can help you avoid this value drain for your equity funds.

Just to recap drawdown…

What’s Equity Release Drawdown?

This is a plan type that only applies to a kind of equity release called lifetime mortgages. Drawdown means that you agree with a lender to borrow a total amount of money but only borrow specific amounts (or drawdowns) whenever you need to. Interest is only charged once you withdraw a part, and this interest will compound if left unpaid.

Now:

This means that the interest is added to the total amount you withdrew, so future interest is added on top of that amount, resulting in increased debt over time.

For example:

You’re approved for an equity release withdrawal of £75,000, and you choose to withdraw only £20,000you decide to leave £55,000 to drawdown later in your life. You’ll just start accruing compound interest on that initial £20,000.

This means flexibility to access your funds whenever it’s needed, for example, if your care becomes very expensive or you need to help out a family member by withdrawing the money only as you need it. When you need it, the loan’s total cost will be lower than if you were to withdraw the total amount upfront.

However…

The interest rate changes or usually differs between your initial loan and your future drawdown amounts.

How does all this affect your pension?

Secure pension

We’ve talked about pension briefly already, but let’s dive a little deeper now.

Pension rules have changed over the years, and you’re now enabled to pass on your pension assets outside your estate to beneficiaries or family members. People do this for Inheritance Tax reasons. That’s why equity release is such a popular way to raise money for retirement by leaving your beneficiaries’ pension savings.

Now:

Even though it took some time for people to become comfortable with this method of saving money for retirement, it’s trendy. I mean, who doesn’t want pension freedom? This has had a very positive effect on the equity release market.

Best of all:

People are looking for a comfortable and luxurious retirement as they’ve worked hard all their lives. However, they don’t want to outlive their savings either. So, they leave a reasonable amount for their loved family members.

Simply put:

Pensions are seen as an asset nowadays, thanks to equity release. The taxes are glorious for those in retirement, as there isn’t much to be paid in the first place! It’s a win-win situation.

Let’s bust the myth…

If you own a house, you can most definitely count on it, unlike in the past. Today, you can see savings from your home instead of from the bank. Modern-day savings aren’t just assets and pensions anymore, but equity locked up in your home as well.

So, what does this mean for you?

Equity-Release Lending Is Increasing

Due to the significant benefits of releasing tax-free cash from your home, the equity release market is growing as people realise their excellent opportunities!

More than £1 billion was released at the end of 2019 and £3.92 billion in 2020. According to the equity release sector’s trade body, more than 85,000 older homeowners used their property wealth in 2020.

Now:

Even though the money release is tax-free, broader tax implications need to be noted. For example, if you’re not planning to use your money right away, you should be aware of all the tax implications.

Our advice?

Speak To a Financial Adviser

Our advice is to ask for more professional and financial advice. Even better would be to speak with an equity release professional. They won’t put any obligation on you. But they’re good at doing personalized recommendations and individual plans according to your circumstances.

Common Questions

Is Money Released Through Equity Taxable?
Why Don’t I Have to Pay IHT?
What is Income Tax on Equity Release?
Will I Need to Pay CGT?

In Conclusion

While you don’t pay tax on equity release, you must be fully aware of everything regarding taxes on equity release, all the possible plans that are available etc., the more you know, the better. In this case, curiosity won’t kill the cat, and ignorance isn’t bliss.

Do You Want to Save on Tax?

Most people are overpaying and could save a fortune with the correct advice. Get matched with an expert and check your eligibility for tax-effective options.

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