Equity Release
What is Equity Release?
Equity Release is a way of releasing the tax-free cash tied up in your property without having to sell it and move to another home. You can either borrow against the value of your home or sell all or part of it in exchange for a lump sum or a regular monthly income. Some plans give you the option to “draw down” further equity (cash) at a later date, based on your requirements.
Equity Release is designed to help customers over the age of 55 who either own their property outright, or with a mortgage (this will need to be cleared upon completion, possibly with the Equity Release funds).
They may decide to “release equity” in their property – that is, take out a loan (Lifetime Mortgage)
The Lifetime Mortgage sum will be repaid at a future date, when the property is sold. Usually, this is done when the borrower (or the last borrower if jointly owned) dies or goes into care.
Lifetime Mortgage
A Lifetime Mortgage is a type of mortgage where you can choose to extract your funds in a single lump sum or in smaller amounts over time up to the maximum limit agreed with the plan provider (Drawdown Lifetime Mortgage). You can also elect to ringfence some of the value of your property as an inheritance for your family, meaning that you can benefit from releasing equity while ensuring you have something to pass on to your children. The interest rate is usually at a fixed rate for the life of the mortgage.
You retain full ownership of your home and interest on the loan can be paid or rolled up. If you are part of a couple, the repayment does not have to be repaid until the last remaining person living in the home either dies or moves into permanent long-term care.
In other words, both you and your partner are free to live in your home for as long as you are able to. With some plans you can make monthly/regular interest repayments in part, or in full. That way, you can maintain the debt to the initial amount of the loan before interest. If you choose to make interest repayments, you still have the option to move to a roll up arrangement at a later date if you wish. There are even some lenders who can offer you the option to pay some capital throughout the plan but always discuss details about this with your plan provider.
How much can be released is dependent on your age and the value of your property. Some providers may offer larger sums to those with certain past or present medical conditions, or even ‘lifestyle factors’ such as smoking habit. These are called enhanced Lifetime Mortgages.
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Equity Release uses:
IHT planning using equity release
Does equity Release reduce inheritance tax?
Your house is probably the largest asset you own and will probably represent most of your estate when you die. When you release equity from your home, does it reduce your inheritance tax liability?
The overall value of your estate is reduced in two ways, firstly when you free up equity, cash for yourself, the value diminishes. Secondly the money used from the property to repay the equity release loan is also deducted from the inheritance, so the value of your estate reduces.
However, it’s not completely black and white, there are some caveats to consider.
What is the inheritance tax threshold?
A direct descendant, like a grandchild, child or stepchild, can inherit your home. This raises the tax-free threshold for each spouse or partner by £175,000 (for the tax year 2023/2024) to £500,000 for each person.
When is Inheritance Tax due?
IHT is a tax on the estate of someone who has died and on any lifetime gifts they made in the 7 years before their death.
You have to pay it unless you use the spouse exemption, which means that you can give your whole estate to your spouse or registered civil partner, so long as they live in the UK.
In the UK, if you don’t do this and your estate is worth more than £325,000 for an individual or potentially £650,000 for a married couple/civil partner when the first spouse or partner dies, then your beneficiaries will have to pay 40% of the amount over this threshold.
Inheritance Tax when gifting equity release funds
If you gift someone money by releasing equity, this money will not be taxed if you live for seven years and don’t get any money back. However, if you die within the next seven years, the gift will be taken into account when figuring out how much tax is due.
Giving more than £325,000 to a non-exempt recipient and dying three to seven years later may cause a tax liability.
Equity release and estate planning can be a technical minefield to navigate.
Lifetime mortgage and inheritance tax planning
Inheritance tax planning can be complemented with a number of equity release products. A lifetime mortgage can help reduce the amount of inheritance tax payable.
Here are a couple of examples to illustrate the different ways a lifetime mortgage can be used to compliment Inheritance Tax Planning.
Example 1
Mr & Mrs Smith are 71 and 70 years old respectively. They own their home outright and it’s worth £1,500,000. They have a comfortable lifestyle, and their income covers their usual expenses, they can afford to go on holiday but there’s very little leftover.
They have one daughter and three grandchildren. A lifetime mortgage with a reserve facility will allow them to drawdown ‘small amounts’, between £500 and £50,000, as and when they wanted/needed it.
This may enable them to take advantage of the various gift allowances available. Each year, they can make gifts of up to £3,000* without incurring IHT. This means they can each give £6,000 away. They can also make as many little gifts of £250* as they choose, as well as a wedding gift of £2,500* to each grandchild. Gifts to charity or political parties are also tax free.
Example 2
Using a Lifetime Mortgage to reduce inheritance tax, Mrs Smith is 73 years old. She was widowed 1 year ago, and her husband left all of his wealth to her. She owns a bungalow worth £2.5million and her assets are worth around £300,000. She has two daughters who will be the sole beneficiaries of her estate.
Without any IHT planning her daughters could be faced with a large IHT bill of £860,000 based on a £2.8million estate. Equity release with a lifetime mortgage of £1.2million has allowed her to make gifts of £600,000 to each of her daughters while still retaining £1.3million in equity in case she needs to move into care or downsize.
Her daughters have agreed to pay the interest on the lifetime mortgage each month keeping it at £1.2million. Providing she lives for at least seven years these gifts fall outside of her estate for inheritance tax purposes.
The remaining debt will reduce of the value of her estate by £1.2million, which in turn will reduce or even eliminate the IHT bill saving her around £620,000.
Gifting Family
This purpose has certainly grown in the past few years. Borrowers can raise funds on their home via an Equity Release plan in order to gift family members.
Typically, this would be for their children or grandchildren to purchase property, pay off their own mortgages or pay for school/university fees. Sometimes there can be a benefit in relation to Inheritance tax too.
Clearing Existing Debt or Mortgages
This is an area which has seen a huge increase over the last few years. Some people struggle with monthly outlay on mortgages and debts and can use Equity Release to free up monthly income. Interest-only mortgages coming to the end of the term can be cleared by using Equity Release.
You should be aware that whilst this may reduce your monthly outgoings in the short term, the total amount repayable is likely to be greater due to the longer term. Make sure you fully understand the implications and risks inherent in securing credit, which was previously unsecured against your home.
Pay for care in the home
We have seen an increase in people wanting to stay in their own home and cover care costs, as opposed to going into a residential care home.
Often, the family of the person needing the care, can discuss whether this is a viable option. In many cases, these plans are arranged under a Power of Attorney document or a Court of Protection order.
Funding Lifestyle or Boosting retirement income
This has been one of the more traditional uses of Equity Release. With people living longer in Retirement, borrowers can continue to travel and have a lifestyle they wish to have. Drawdown Lifetime Mortgages can be a way of achieving this.
Equity released from your home will be secured against it
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