Since the government announced an individual’s pension would become part of their estate from 2027, the number of individuals looking for ways to decrease the value of their estate has significantly risen.
There are numerous strategies used to relieve the inheritance burden on future generations, and many people are looking into equity release as a tool to ease this bill.
In this article, we’ll explore some of the more important details of equity release, including what it is and who could benefit from it.
The taxable amount is increasing
An individual’s estate is made up of assets and debts, meaning their property, cash, belongings, investments and other assets fall into this bucket. And from 2027, their pension will become part of their estate for inheritance tax (IHT) purposes.
This measure has generated some concern among those – many of whom are homeowners – who have been saving for retirement through a pension, and this change has encouraged them to seek financial advice to understand how their IHT bill could be minimised.
For some of those individuals, equity release could be part of an effective strategy to optimise the use of their tax allowances and lower the IHT bill they could leave for future generations.
Reducing the size of your estate
Through equity release, you can borrow money secured against the value of your property. Once that capital is available, it can be used as income to fund retirement or could be gifted. Gifts fall outside of the estate after seven years, before then it works on a tapered basis with part still being liable to IHT dependent on when the gift was given. Therefore, we suggest you consider seeking financial advice if you’re gifting large sums to check whether considering purchasing a protection policy.
The loan can be taken as a lump sum or as an initial lump sum plus a reserve facility, you only pay interest on the initial lump sum until any additional funds are drawn. In addition, you should never run the risk of negative equity on your property, and most equity release schemes guarantee you will never owe more than the value of your property.
The outstanding balance someone borrows through equity release is typically due for payment when they permanently move into long-term care or pass away.
At the time of writing, IHT is charged at the standard rate of 40% and applied over the estate above the threshold. As rules stand, the nil-rate band (i.e. the amount below which no tax is payable) is £325,000 and can increase to £500,000 if you give away your home to your children or grandchildren.
For many, property represents their largest assets by value, and therefore taking up equity release could relieve the IHT burden associated with these assets. To do so, individuals would release equity from their property and make gifts to their loved ones.
Example
For simplicity, let’s consider an individual has a property worth £5m and the remainder of their estate is worth £1,325,000.
For inheritance tax purposes, £325,000 of other assets offsets the nil-rate band, which means IHT will be charged on £6m.
At the standard rate of 40%, the IHT bill on this person’s estate would result in a £2.4m bill. If they decided to release £2m worth of equity and gifted that money to their children, that amount would no longer be part of their estate (again, considering the person didn’t die until seven years after they’ve gifted the money).
So, as the value would from then be valued at £4m, the IHT amount due would fall to £1.6m, representing a reduction of £800,000 through equity release. However, it is important to note that the equity release facility must be repaid and serviced. Depending on the type of borrowing selected, this may involve either monthly interest payments or interest that accrues and is deducted from the estate upon death. Both options would reduce the net tax saving.
The art of estate planning
There are various forms of equity release, the most popular of which is a lifetime mortgage. These are similar to traditional mortgages; however, the providers tend to be either pension companies or specialist equity release companies. The rates are fixed for life and are linked to gilt or annuity rates, rather the Bank of England base rate, and there is no specific end date as to when it is to be repaid.
Other than that, similar to standard fixed-rate mortgages, they have set early repayment charges for a specific period usually between 5- 15 years. However, these are often waived if you decide to sell your property and downsize. You also have flexible options regarding the interest payments; you can pay the full interest to maintain the existing loan amount, pay a portion of the interest based on affordability, or allow interest to roll up over time. They do also allow the 10% overpayments per annum without charge as per standard mortgages.
Like with most things in life, equity release has its advantages and disadvantages. While it might be worth considering easing the IHT burden you might leave behind, it’s also extremely important to consider the impact this might have on the downside.
As with any financial instrument, equity release carries an amount of risk which might not be suitable for everyone. For instance, releasing too much equity might impact the ability to pay for long-term care or release additional funds if required in the future. It’s also worth noting that interest rates on lifetime mortgages are typically higher than those of traditional mortgages.
We recommend seeking financial advice to understand the risks and benefits associated with equity release before making any financial decisions.
It’s always worth remembering that, while equity release might be a beneficial tool for some individuals or families, it might be less relevant for some. This depends on people’s objectives and priorities, and the best financial plans will have these aspects at their core.
At Partners Wealth Management our strategy is to first understand our clients’ objectives, and then to produce a financial plan designed to help you in every stage of your life, fully tailored to your view of what it means to have financial freedom. If you’d like to find out more how managing your property could fit into your financial plans, do not hesitate to get in touch with us. Please contact the team on 020 7444 4030 or email us.
Rebecca Rider
Partner
rrider@partnerswealthmanagement.co.uk
020 7444 4042
The contents of the article have been prepared solely for information purposes. The article contains information on financial products and services and such information is designed for and addressed solely to individuals seeking generic industry information. Past performance is no guide to future returns. The above content does not represent a personal recommendation. Your home is at risk of repossession if you do not maintain mortgage payments.