Do You Pay Tax on Equity Release?

Man and woman sitting on sofa comforting each other

Benjamin Franklin once said; “in this world, nothing can be said to be certain, except death and taxes.”

With both death and taxes being an important consideration of equity release, you may be wondering whether you have to pay tax on equity release.

It’s a common assumption that if you are receiving a big lumpsum of money you will need to pay tax on it.

In most cases of equity release you might be surprised to learn tax isn’t applicable.

Unforeseen taxation can be a burden to anyone and there are times where your equity release could open you up to a tax liability.

These instances are rare and this guide outlines everything you need to know about when tax is applied to equity release.

What is Equity Release?

Equity release is a financial product which allows you to free up the cash tied up in the equity of your property.

It works in one of two ways in the UK.

Lifetime Mortgages

Lifetime mortgages are available to anyone over the age of 55 with a property valued over £70,000.

You can typically borrow up to 50% of the property value or in other terms, release up to 50% of the equity.

As you might have gathered, a lifetime mortgage is a loan, and a lender will lend you the amount of money equal to the equity you want to release. 

Unlike a traditional mortgage, a lifetime mortgage does not have a mandatory monthly repayment and instead the interest is calculated and accrues over the time you have the equity release.

Ordinarily, the term of the equity release lasts until you die or go into long-term care although you can pay back equity release early in most cases.

When you pass away (or require long-term care) the lender may sell your property to repay the loan capital and interest if your beneficiaries are unable to refinance/sell it themselves.

Lifetime mortgages are the most popular equity release product in the UK, currently accounting for 99% of the equity release market.

Home Reversion Plans

Home reversion plans are not loans, instead you sell a portion of the equity to a plan provider upfront.

The provider will then sell the property when you die or go into long-term care to recoup the money, they gave you for the equity.

Home reversion plans are good for anyone not wanting to take out a secured loan, however, the product is normally uncompetitive compared to a lifetime mortgage.

This is because a lifetime mortgage lender will release the equity at market value, whereas a home reversion plan provider will offer an amount lower (in most cases substantially lower) than market value.

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Is Equity Release Taxed?

Now we have got to grips with the fundamentals of equity release, let’s look at tax.

In almost all cases the initial equity release amount from the lender or provider is not subject to tax.

The payments are tax-free lumpsums. 

You can find difficulties with tax however if you drawdown your equity release as a regular payment and already have a substantial income.

In rare cases, regular payments can be subject to income tax.

If you’re looking to take your equity release as a regular payment and have other avenues of income, it is worth consulting a tax adviser to ensure you have no additional income tax liability.

The other aspect of taxation that can come into play with equity release is inheritance tax more on this further down.

Why is Equity Release Not Taxed in General?

Equity release is considered a lifeline product that allows older people to fund their lifestyle in later years.

As many people find their income reduced in later years, equity release can be the difference in maintaining a reasonable standard of life.

As a result, the government has chosen not to penalise those taking equity release products with tax.

The overall thought process is the funds are essential for older people in most cases and taxation wouldn’t be fair and could cause financial hardship. 

Another reason is equity release is a secured loan rather than a sale of the equity.

Even home reversion plans have a loan aspect because a charge is placed on your property by the provider.

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Types of Taxes You Might Have to Pay

Equity release isn’t tax-free in all circumstances though, below we outline the types of taxes that might apply to equity release.

Income Tax

Most online resources about equity release will note there is NO income tax on equity release.

Equity release isn’t a form of income even when drawn down in regular payments so it should not become an issue for income tax.

For lifetime mortgage products, equity release is exempt from income tax as it is a loan and not income.

Income tax is a bit more complicated than most online articles would have you imagine though.

In extremely rare cases, an equity release payment can take you above the tax-free threshold for savings.

For example, the payment itself is exempt from income tax, but if it is paid into a savings account and you get interest on the money, it can take you above the tax-free threshold.

This is typically a complication if you have substantial savings already, a high level of external income from pensions or work or a large investment portfolio.

If these situations apply to you, it is worth discussing your equity release payments with a tax adviser.

Capital Gains Tax

Capital gains tax is charged in the UK when you dispose of an asset.

As you will not be disposing of an asset with equity release the payment is exempt.

Equity release always results in a company putting a charge on your property which allows them to claim their financial interest in the property when you die or go into long-term care.

For this reason, it is treated like a mortgage (loan), and you won’t be selling or disposing of the equity.

This is even the case with home reversion plans.

If you invest the money from your equity release in cars, works of art or antiques which you sell at a later date, the disposal of these assets will be subject to capital gains tax.

The key thing here is your initial payment from the equity release isn’t subject to capital gains tax and tax liability is only encountered if you opt to buy and subsequently sell an investment with that money.

Inheritance Tax

Perhaps the most important form of tax to consider with equity release is inheritance tax.

In the following section, we explore inheritance tax in detail.

In some cases, equity release can be used to reduce an inheritance tax liability.

Can Equity Release be Used to Reduce Inheritance Tax (IHT)?

Yes, many people use equity release to reduce an inheritance tax liability.

Reducing inheritance tax with equity release works in a number of ways.

Before we look at reducing the inheritance tax liability, let’s first look at how inheritance tax works.

What is Inheritance Tax?

Tying back to the quote at the beginning of our article – in life, you’re assured of both death and taxes.

In the case of death in the UK, if you have money above a set threshold, you will be charged tax for any money left as an inheritance.

When you die in the UK your money, property and possessions will go into your ‘estate’.

Your estate is a pool of everything you’ve left behind at the point of dying.

If you have made a will, your estate will be distributed according to your wishes by your executor to your beneficiaries.

If you haven’t made a will, your estate will be distributed according to the rules of intestacy.

Before any distribution occurs, the government will tally up the total monetary value of your estate.

If this exceeds the threshold, an inheritance tax charge will be applied.

If a charge is applied, the tax will need to be settled before the estate can be distributed.

In some cases, the next of kin can not afford the inheritance tax bill and bridging loans are a common way to settle inheritance tax liabilities in these circumstances.

Married Couples and Inheritance Tax

If you’re married in the UK, you have a higher inheritance tax allowance and you can leave your estate to your partner tax-free.

Upon the second person’s death the inheritance tax becomes payable (but at the higher threshold).

The nil rate band (threshold) for inheritance tax is £325,000.

For married couples when the first partner dies their £325,000 can be transferred to the second partner giving a tax-free threshold of £650,000.

When the second partner dies and the inheritance is passed on to the next beneficiaries, those receiving the inheritance will only have to pay tax on anything over £650,000.

There were legal rule changes in 1986, so if your spouse died a long time ago you will need to discuss the situation with a tax adviser as the thresholds mentioned above may not apply.

How Does Inheritance Tax Work?

The simplest way to explain inheritance tax is every person in the UK has a nil rate band of £325,000.

If you’re married this can be passed onto your spouse as discussed above.

If you leave your main property (residence) to your children, stepchildren or grandchildren then the threshold limit increases to £475,000 which is known as the residence nil rate band.

When you die your assets are pooled into your estate and HMRC will value everything in the pool.

If the estate is less than the threshold, no inheritance tax will be applied. If the estate is over the threshold, anything above the nil rate band will be subject to tax.

Currently, the inheritance tax rate is 40% of anything above the nil rate band that applies to you.

For example, a single person who passes away with an estate of £800,000 will have a tax liability on the remaining £475,000 after the nil rate band is taken into account.

Can You Gift Equity Release Funds?

Yes, you can do what you please with the money released from equity as long as it is for legal purposes.

You may find you still have an inheritance tax liability if you choose to gift the funds.

Gifting and Inheritance Tax

In the UK there is what’s known as the seven-year rule for gifting.

If you gift money and die during the seven years, your beneficiary could still be liable for inheritance tax for any money over the nil rate band.

Time Between Gift and Death Inheritance Tax Rate Payable
Less than 3 Years 40%
3-4 Years 32%
4-5 Years 24%
5-6 Years 16%
6-7 Years 8%
Over 7 Years 0%

 

In the UK you can give up to £3000 a year without it triggering the inheritance tax gift rules above this is known as a gift allowance.

The allowance varies according to the type of gift you’re making.

Using Equity Release for Estate Planning

Equity release is considered a debt or liability.

This means when your estate value is calculated, the value of the equity release is deducted from the estate value.

Because of this, although your property would traditionally count toward an inheritance tax calculation, it is removed in part or in full from the equation. 

Having an equity release product will release your total estate value, and in some cases could even ensure your estate total is below the nil rate band.

This makes it attractive to homeowners who would ordinarily have an inheritance tax liability and can reduce it by releasing the funds from the equity in a tax-free way.

Equity release is a significant financial commitment, and you will need to discuss your personal situation in detail with a qualified equity release adviser.

Boon Brokers is a whole of market mortgage, insurance and equity release broker. Boon Brokers provides fee FREE, independent advice for anyone considering equity release. 

Contact Boon Brokers today.

Gerard BoonB.A. (Hons), CeMAP, CeRER

Gerard is a co-founder and partner of Boon Brokers. Having studied many areas of financial services at the University of Leeds, and following completion of his CeMAP and CeRER qualifications, Gerard has acquired a vast knowledge of the mortgage, insurance and equity release industry.