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Equity Release Tax Implications

As the saying goes, two things are certain in life: death and taxes. This saying is no more relevant than in equity releases.

Equity release is a concern to many as there’s an idea that it will be taxed, throwing the idea of taking out plans into jeopardy. This guide will debunk the tax implications of equity release.

Is Equity Release Taxed?

There is always concern from those considering equity release that their funds will get taxed, making it trickier for estate planning and budgeting for retirement. Older persons use equity release to unlock funds against a percentage of the value of their home, but potentially being taxed may see them with significantly less cash.

The main categories of tax concern for equity release are income tax, capital gains tax, and inheritance tax? So are any of these subject to taxation?

Income and capital gains are not taxed. However, equity release could be subject to inheritance tax.

We’ll go into more detail below.

Income Tax

Equity release is not subject to this tax because it’s not an income stream. Like mortgages, the funds are not earned from any employment or investments but borrowed from a lender or bank. They, therefore, get categorised as a loan.

Income tax concerns derive from many homeowners using equity releases to top their income. However, even if equity release gets used for that purpose, it’s still considered borrowed money and therefore not subject to taxation.

The only reason that your equity release would get taxed as income is if the money received was invested in something. You will get taxed on the interest received as income tax if the funds get deposited in a savings account.

Capital Gains Tax (CGT)

The reason why concerns are buzzing around CGT is that most of these taxes are associated with properties. Equity release is funds gained from exchanging a percentage of your property and feels like a sale of part of your home.

CGT itself is a tax on the profit on the sale of an asset that’s increased in value. Should you sell a property worth more now than what you paid for it, the difference you make could be subject to taxation.

However, CGT does not apply to equity release, primarily because the loan usually gets taken out against your primary residential property. That means that the home receives a listing in ‘Private Residence Relief’ and is exempt from CGT.

Taking out an equity release plan doesn’t impact property values, and CGT does not apply to the asset.

Inheritance Tax

Will equity release affect inheritance? Inheritance Tax (IHT) is the only actual instance your equity release might get taxed after you pass away. However, not everybody has to pay it pending certain circumstances.

The main reason IHT applies to equity release is that the plans could affect the value of your estate. First, let’s recap how inheritance tax works.

IHT is a tax on all funds and assets within a person’s estate after they die if it exceeds a threshold of £325,000. However, if the estate gets passed to a spouse or civil partner, IHT won’t apply but will if it’s a child or grandchild where the threshold rises to £475,000.

Suppose the estate passes to somebody who is not a spouse or civil partner and is above the threshold mentioned above. In that case, an IHT of 40% on the estate applies. Even if you give an early inheritance to your loved ones, if it’s seven years after passing away, it’s included in the value of your estate and subject to IHT.

Why is Equity Release Subject to Inheritance Tax?

Financial gifts within seven years before death are subject to IHT is the fundamental reason why equity releases could get taxed. Many homeowners take out plans for estate planning reasons and pass on a significant portion of the funds before they pass away.

But should pass within seven years of giving the money to loved ones, that ‘gift’ becomes taxable. Any savings held from your equity release funds will also get considered part of your estate, possibly subject to IHT.

How Much IHT Will I Have to Pay?

If the estate has a value of over £325,000, the beneficiary will pay 40% IHT.

For example, if you had an estate of £700,000, IHT would only apply to any funds past the £325,000 threshold. That means only £375,000 out of the original sum would get taxed at the IHT rate of 40%, or you’d pay £150,000.

It seems like much money to pay on money taken out to provide an inheritance for your loved ones. If the estate is worth over £325,000, is there any way to reduce IHT on equity release?

Can I Reduce IHT on Equity Release?

There are ways to use equity release to reduce the amount of IHT paid. The primary example takes out an equity release loan on their property, accruing enough interest that the sum would get taken away from the value of their estate.

An example of this would be taking out a lifetime mortgage of £267,000 with an interest rate of 4%. It will accrue enough to get to around £325,000 owed. Now say your estate was £700,000 with £300,000 in equity release; that leaves your estate with £400,000.

Minus the £325,000 threshold, the amount left subject to tax is £75,000 – with 40% IHT, you’ll pay £30,000.

Another way to reduce IHT on equity release is ‘gifting’ the inheritance well in advance. We mentioned that all financial gifts to loved ones are subject to IHT within seven years of passing, but a tax rate scale applies.

The 40% IHT bracket only applies to gifts passed within three or fewer death years, where different rates apply in more years. They are:

  • 3-4 years – 32%
  • 4-5 years – 24%
  • 5-6 years – 16%
  • 6-7 years – 8%
  • Seven years or more – 0%

If you take an equity release and don’t pass away within seven years of gifting your loved ones, they won’t have to pay any IHT, making inheritance tax planning more manageable.

Can Equity Release Help Plan My Estate?

Knowledge and research into an equity release scheme can be an effective way to help plan your estate. You can compare equity release plans to see which ones will benefit you most if you seek to secure a long-term financial future for both yourself and your loved ones.