Equity Release in Inheritance Tax planning

Inheritance Tax is payable on your estate when you pass away. There is no tax to pay if the value of your estate is less than £325,000, or if it is left to a spouse, civil partner or a charity. If you own your home and leave it to your children, this figure can rise to £500,000 providing your estate is worth less than £2 million*. That means, in general, other than the first £325,000 of your estate, or £500,000 if you are a homeowner, your beneficiaries will face an inheritance tax bill at the standard 40% rate on everything they inherit.

Thoughtful planning can see this IHT liability reduced, or even eliminated. We can all pass on assets up to the Nil Rate Band (NRB), currently up to £325,000*, without any IHT, and property owners can also make use of the Residence Nil Rate Band (RNRB), currently up to £175,000*. On top of these Nil Rate Bands, there are reliefs and exemptions which can be used to further reduce your inheritance tax bill.

For example, everyone has an annual gift allowance, currently set at £3,000, that can be given away tax free, as well as a small gift allowance where gifts of up to £250 can be given away as many times as you want. One off gifts can be given for weddings or civil partnerships. You can gift much larger sums in order to reduce the value of your estate, but gifts above the annual allowance only fall outside of the tax regime if you subsequently survive for seven years from the date of the gift.

Certain Trust structures can also form part of the wider plan and it is worth speaking with an estate planning expert to get advice tailored to your situation.

Equity release is used to describe products that allow anyone over 55 to release the wealth – the equity - built up in their home. The most common form of equity release is a lifetime mortgage, a loan secured on your main home. This differs from a regular mortgage because it has no fixed term and repayment is not expected by the lender until the youngest applicant passes away or moves into full-time care. The mortgage is normally repaid from the sale of the house and interest can be paid monthly or allowed to roll up, meaning there are no regular payments to make.

Modern equity release is a fast-evolving market with an ever-wider choice of flexible and sophisticated products.

It can help in several ways. The Residence Nil Rate Band (RNRB) can be used by property owners to reduce their Inheritance Tax liability, currently by up to £175,000, but if the value of your estate exceeds £2 million, your RNRB will reduce, tapering off as the value rises to give some high-value estates no savings at all. Raising a debt against your property could reduce the value of your estate back below £2 million and therefore maximise your RNRB.

Equity release can turn illiquid assets – your house – into liquid funds which can then be used in other forms of IHT planning. Gifting a one-off lump sum, for example, while you are still alive will move the gift out of your estate tax free providing you then live for seven years. A lifetime mortgage could give you options that include passing on your annual allowance or regular small gifts more easily and paying for a child or grandchild’s wedding, all of which takes money out of your estate and therefore lowers the IHT liability further down the line.

Equity release is arguably one of the safest financial services products with a specific set of rules in place. Equity release products are only available through advisers who have obtained FCA permission to recommend them and advisers must hold a separate industry qualification and follow strict criteria before making any recommendation. In addition, the trade body, the Equity Release Council, have a strict set of rules and standards in place which members, including all providers, must adhere to.

It may be that equity release is not the right solution for you, but a different form of finance is. One of our strengths at Knight Frank Finance is that we have access to the broadest range of property finance, which ensures we find the most appropriate solution for your needs and circumstances. We will always take the time to explain the options and find the best fit for you.

Knight Frank Finance are not tax advisers and we always recommend you seek professional advice to ensure the most tax efficient outcome. We work closely with your trusted advisers to ensure we recommend the most suitable solution tailored to your needs and we can even refer you to an appropriate professional should you need help with any aspect of your planning.

This will depend on your life expectancy, so it is difficult to be exact. The average age of our clients taking out a lifetime mortgage is 75, a good time to be proactive, especially if you wish to make a large lump sum gift from your estate under the seven year rule. However it makes sense to start planning as early as you possibly can, to understand the options available to you.

If you have sufficient wealth to support yourself, you can look at reducing the taxable value of your estate from your early 60s and enjoy seeing the value realised from your home put to good use. If you have chosen to let the interest roll up, or compound, rather than pay it monthly, it is important to consider the potential implications of this over a longer period. You can choose to pay some or all the interest each month or repay some of the money you’ve borrowed if you have surplus funds. All products allow you to repay at least 10% of your loan each year without any additional charges, another example of the flexibility in the market.

The maximum amount of equity you can release from your property will depend on your age and the value of your property. As a guide, for a 70-year-old, the maximum you can borrow is around 46% of the property value while for an 80-year-old it’s closer to 55%. Our Equity Release Calculator will give you an idea based on your age and the value of your home. Our clients typically have a property worth £2 million and borrow 25% of the value of their property.

To reduce the taxable value of your estate, you need to move the capital released out of your estate. This is usually done by gifting money to your beneficiaries. However, sensible investment planning and lowering Inheritance Tax liability are key criteria for most of our clients, and equity release provides a wide range of other potential choices too. Regular uses include helping children on to the property ladder, reducing or repaying their existing mortgage, assisting them upsize to a larger house, paying school fees for grandchildren or helping them through university.

If you give a lump sum gift, it will not be considered part of your estate as long as you live for a further seven years. That means the gift has been made from your estate tax free and that money no longer counts towards your Inheritance Tax liability.

There is a sliding scale – “taper relief” - on the tax due should you die within those seven years*. Gifts in excess of the Nil Rate of £325,000 given within three years of your death are fully taxable, i.e. will incur the standard 40% IHT rate. If three-four years have passed then the excess gift is taxed at 32%, four to five years at 24%, five to six at 16% and six to seven at 8%. If you give something as a gift but still benefit from it, passing your house to a relative for example while still living there yourself, then it is considered a “gift with reservation” and will count as part of your estate for tax purposes.

You can contact David Forsdyke who heads up our Later Life Finance team and is widely regarded as an expert on equity release. David has 25 years’ experience in financial services including six with the Financial Conduct Authority (FCA – the industry regulator), two as a member of the Equity Release Council’s Standards Board and three with Knight Frank Finance working with HNW and UHNW clients.

David and his team of specialist Later Life Finance Advisors are available to help with any queries relating to equity release or lifetime mortgages.