Releasing equity from your home can be an effective way to access additional funds for your retirement, home improvements, or other financial goals. However, if you're considering unlocking the value tied up in your property, it's crucial to understand the potential implications it may have on inheritance tax (IHT) in the future. While equity release schemes, such as lifetime mortgages, are increasingly popular, there are tax considerations that need careful attention, especially when it comes to estate planning and what your loved ones will inherit.
In this blog post, we’ll explore what happens to inheritance tax when you release equity from your home and how it could affect the value of your estate.
What is Equity Release?
Before diving into the inheritance tax (IHT) implications, let's quickly recap what equity release is. In the UK, there are two main types of equity release products:
- Lifetime Mortgages: This is the most common form of equity release. You borrow money against the value of your home, but unlike traditional mortgages, you don’t have to make regular repayments. The loan, plus interest, is repaid when you move into long-term care or pass away.
- Home Reversion Plans: This involves selling a portion or the entirety of your property to a reversion company in exchange for a lump sum or regular payments, while still living in the home rent-free.
Both methods allow homeowners aged 55 and over to release money from their property without having to sell it, giving them access to cash for whatever they may need. However, these schemes can have a significant impact on your estate and the amount of inheritance your beneficiaries will eventually receive.
How Equity Release Affects Inheritance Tax (IHT)
Inheritance Tax is levied on the value of your estate when you pass away, including assets such as your home, savings, investments, and personal possessions. If the value of your estate exceeds the £325,000 threshold (as of the 2025/2026 tax year), it may be subject to an inheritance tax rate of 40%.
So, what happens if you release equity from your home? Here are the key points to consider:
1. Reducing the Value of Your Estate
When you release equity from your home, you are essentially borrowing money against the value of the property. This means that the value of your estate could be reduced, which may lower your potential inheritance tax bill.
For example, let’s say you release £50,000 in equity from your home. The amount borrowed will not be included in your estate for inheritance tax purposes (as it is a loan). If the loan and interest are paid off upon your death (through the sale of the property), the overall value of your estate will be lower than if you hadn’t released the equity. This could potentially reduce the amount of IHT payable.
2. Impact of Interest on the Loan
With lifetime mortgages, the loan is typically not repaid until after you pass away. However, the interest on the loan accrues over time, and this could significantly increase the overall amount of debt your estate has to settle. The higher the debt, the less value is left in your estate for your beneficiaries, and this could reduce the amount they inherit.
While the loan itself isn’t subject to inheritance tax, the growing interest on that loan over time may still impact the net value of your estate. This is important to bear in mind if you're considering how much you wish to leave to your beneficiaries.
3. Gifts and the Seven-Year Rule
One of the key concepts in inheritance tax planning is the seven-year rule. If you give away assets or release equity from your home to make a gift, it may fall under the rule of "gifts with reservation of benefit." This means that if you retain any benefit from the gift (for example, you release equity and continue living in the property), it may still be considered part of your estate for IHT purposes.
However, if you give away a portion of your home and live for at least seven years after making the gift, that portion may be exempt from IHT, assuming it is no longer part of your estate. If you release equity and then live for seven or more years, the amount borrowed won’t be included in your estate for inheritance tax purposes, though the increased debt would still need to be paid from your estate.
4. The Property Still Forms Part of Your Estate
Even if you release equity from your home, the property itself will still be considered part of your estate when you pass away. If your home’s value continues to rise, that increase could be subject to inheritance tax, regardless of any equity you have released. This means that while the amount you owe on the mortgage or loan will be deducted from your property’s value, the remaining value of the property could still attract an inheritance tax bill if it exceeds the £325,000 threshold.
What Are the Options for Minimising Inheritance Tax When Using Equity Release?
If you are concerned about inheritance tax and want to minimize its impact on your estate, there are a few strategies you can consider when releasing equity from your home:
1. Use a Trust
One option is to place your home into a trust. This can be done while you are alive or as part of your will. By placing your property into a trust, it may be possible to reduce the value of your estate for IHT purposes, as the property is no longer directly in your name.
However, there are strict rules about how trusts work, and if you still live in the property after placing it in a trust, you may face tax implications. It’s essential to consult with a tax advisor or solicitor who can guide you through the complexities of trusts and inheritance tax.
2. Use the £3,000 Annual Exemption for Gifts
You are allowed to gift up to £3,000 per year without it being counted towards the value of your estate for inheritance tax purposes. If you’re planning to release equity from your home, you might want to use this exemption to make gifts to loved ones while you’re still alive, which can help reduce your estate’s value over time.
3. Plan for the Long-Term
If you’re planning to release equity from your home to fund your retirement or other needs, it’s important to take a long-term view. Consider how the release of equity, coupled with any accrued interest, will affect the value of your estate, and discuss the potential inheritance tax implications with a financial planner. The goal is to strike a balance between enjoying the benefits of equity release today and ensuring that your beneficiaries receive a fair inheritance in the future.
Final Thoughts
Releasing equity from your home can be a useful financial tool, but it’s essential to consider its impact on inheritance tax and your estate as a whole. While equity release may reduce the overall value of your estate by lowering the amount of equity you own, it also introduces potential complexities, especially regarding how the loan and interest are handled after your death.
To make informed decisions, it’s crucial to consult with a financial advisor or estate planning expert who can help you navigate the implications of equity release and inheritance tax, ensuring that both your financial needs and your legacy are carefully planned for.
If you’re considering releasing equity from your home, make sure you’re fully aware of the long-term effects on your estate and inheritance tax obligations. After all, the goal is to balance the benefits you gain today with the inheritance you leave for your loved ones in the future.
