Equity Release Tax in Oct 2021

Save a Fortune on Inheritance Tax With Equity Release: Here's How!

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.

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Equity Release & Tax: Are You Saving Tax With This Efficient Structure?

A Quick Intro to Taxes & Equity Release. What You Need to Know

An increasing number of older homeowners are inquiring about equity release schemes as a means to unlock wealth from their homes. Still, many are also asking the question, “will 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 money away for retirement or to buy another home.

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.

First, you need to look for lenders who are members of the Equity Release Council (ERC)1 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.

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.

Equity Release Impact on Taxes & Which 2 Types to Consider

Income tax2 and capital gains tax are the 2 primary taxes that people like to discuss. Luckily, equity release has no impact on either of these. This is why.

Income Tax

Do you know that 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.

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. This allows you to release cash from your home in 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 also doesn’t charge interest.

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, with a min 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.

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.

Capital Gains Tax (CGT)

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

If your property is an asset, shouldn’t you be charged capital gains tax3 if you sell that asset? The answer is NO. Thanks to the Private Residence Relief4, there’s a total exemption if the property is your primary residence.

As a bonus, you can also get equity release on your second or buy-to-let properties. And, the good news is that you’ll also be exempt from GCT on these, even if it’s not your primary residence or property.

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.

Equity Release Tax

How Can Equity Release Be Used to Decrease Taxes?

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

The Nagging Implications of Inheritance Tax (IHT) & How to Overcome It

IHT is a tax charged on the property of someone who died. Luckily, some people don’t have to pay this due to the threshold of £325,000. Meaning, if your estate or property is valued less than that amount, you won’t have to pay any IHT on it.

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, IHT5 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.

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

An Example Of Inheritance Tax WITHOUT Equity Release

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.

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.

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.

IHT on An Estate Worth £700,000

  Threshold Total
  £325,000 £375,000
Inheritance Tax (IHT)   40%
Total IHT Payable   £150,000

How Can Equity Release Reduce Your Inheritance Tax 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 IHT, 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 £325,000 leaving you with £75,000.

IHT & Equity Release on An Estate Worth £700,000

  Threshold Equity Released Total
  £325,000 £300,000 £325,000
Inheritance Tax (IHT)     40%
Total IHT Payable     £30,000
Total Amount Saved     £120,000

Gifting as an Early Inheritance to Save a Fortune on Inheritance Tax

Generally, people like to use the 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.

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.

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

Early Inheritance Gifts & IHT

Years Between Gift & 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%
Equity Release Tax

The Booming Equity Release Market & Why It’s a Good Thing

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.

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 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 and they’re good at doing personalised recommendations and individual plans according to your circumstances.

Got Questions? Check These First

Is Money Released Through Equity Release Taxable?

Why Don’t I Have to Pay IHT with Equity Release?

What's Income Tax on Equity Release?

Will I Need to Pay CGT on Equity Release?

Is Equity Release Tax-Free?

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.

Editorial Note: This content has been independently collected by the SovereignBoss advisor team and is offered on a non-advised basis. Sovereignboss may earn a commission on sales made from partner links on this page, but that doesn’t affect our editors’ opinions or evaluations.

Contributors: Nicola Date, Katherine Read
Reviewed by Francis Hui

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Rachel Wait
Personal Finance Journalist

Rachel is an experienced finance journalist and editor with a particular interest in personal finance and consumer affairs. She has vast experience writing about money issues, property, insurance, and consumer affairs, and you’ll find her articles regularly featured in top media and newspaper publications.
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John is passionate about education and has made it his life-long mission to assist UK citizens on their future financial options, with a specialist interest in equity release, and SovereignBoss is the natural extension of this passion.
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Having held various high-level roles across the industry, Francis is truly an expert in aiding UK citizens in their financial decisions and risk analysis. His unique insight and statistical knowledge make him the perfect person to help you take your financial future to the next level.
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Since joining the editorial team at SovereignBoss, Katherine has become focused on bringing transparency to finances and opportunities for those approaching retirement age. She writes on the topics of equity release, home reversion, and mortgages.
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Nicola is a financial writer for SovereignBoss and is passionate about the opportunities that equity release can open up for homeowners. Her extensive business experience and deep understanding of the industry means that she’s always up-to-date with the latest developments.

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