The tax implications of equity release

Last updated 25^th October 2023

6 min read

You do not need to pay tax on any money you receive through equity release. An equity release lump sum could even reduce the tax you need to pay on other assets in your estate, depending on how you make use of the funds.

While there is no tax to be paid on your equity release, it is a loan and will accrue interest, which will be paid back from your estate after death.

When making a decision, it is important to consider all of the pros and cons of equity release, not just the tax implications.

Why is equity release not taxable?

Equity release is not taxable because it is a loan. This means it is exempt from the taxes that apply when you gain money through regular income or other means, like interest on savings.

Income Tax

The money you release from your home is not taxable as an income (because it is a loan). But, the actions you take with it could lead to a requirement for Income Tax.

Your released equity could lead to Income Tax if it is used to gain income through savings, investments, dividends and the like. But, the tax will only apply to the additional money you gain (e.g. interest added on a savings account), not the original equity release sum.

You have a tax-free allowance (sometimes called your 'Personal Allowance') of up to £12,570 a year for income from wages, your pension, and other sources. Only earnings above this amount will be subject to income tax.

If your wages or pension do not use up this allowance, any interest being earned on your savings can also be counted towards it.

If your income from sources other than savings is less than £17,570, you gain up to an additional £5,000 tax-free allowance for your savings income. You can learn more on GOV.UK(website opens in a new tab).

Capital Gains Tax

Capital Gains Tax is commonly associated with profits from property sales, which may seem like a clear link to equity release. However, equity release is classed as a loan, as opposed to a sale, and Capital Gains Tax is only charged when an asset is ‘disposed of’.

In the same way that a regular mortgage loan is not subject to a tax, equity release is also free from Capital Gains Tax.

As with Income Tax, there are circumstances in which equity release money might lead to Capital Gains Tax. To adapt the example from GOV.UK(website opens in a new tab), if you buy a painting for £5,000 with your equity release money, and later sell it for £25,000, the £20,000 profit (‘gain’) is taxable.

However, the money that would be taxed is the money gained from the sale, not any part of your original equity release sum.

Does equity release reduce Inheritance Tax?

One of the most significant tax implications of equity release is the reduction it can make to your estate’s Inheritance Tax (IHT). Equity release can help reduce your estate’s value down towards the tax-free threshold while still giving you access to your money.

If your equity release cash is spent on things that will not count towards your estate (like a holiday or an experience), you’ll see the full benefit of that money without it being taxed after your death.

Other things to consider

The standard tax-free allowance for an inheritance is £325,000, though it increases to £500,000 if your estate includes your home and is left to your children, step-children or grandchildren. The value of your estate in excess of your allowance will be taxed at a rate of 40%, unless over 10% is gifted to charity, in which case the rate falls to 36%.

If your estate is left to your spouse or civil partner, you do not have to pay any tax straight away. Instead, your tax-free allowance will be added onto theirs when they pass away. This allows married couples and civil partners to double the shared allowance for their estate. So, if you are married or in a civil partnership, the benefits of equity release on inheritance tax will only be seen once the estate passes to your children or another party.

Take a look at our guide to inheritance for a more detailed breakdown.

In order for equity release to reduce Inheritance Tax, the funds need to be used in such a way that they reduce your estate’s value down towards or below the thresholds. You can do this in a number of ways, including:

• Spending the money on things that won’t become a part of your estate, like a holiday or an experience.
• Donating to charity.
• Living off your equity release money and saving your private pension.
• Gifting money to your loved ones before you die so that you can see them enjoy it.

Using your equity release money to save your private pension

Money withdrawn from private pension funds is subject to Income Tax above the tax-free allowance, but, pension pots themselves aren’t usually part of your estate(www.standardlife.co.uk opens in a new tab). This means they don’t usually qualify for Inheritance Tax when passed on.

This will depend on the type of pension scheme you use, but modern, flexible pensions can usually be passed on tax-free if you die before the age of 75. This is known as a death benefit. If you die after this age, your beneficiaries will pay income tax on anything they take from your pension pot. So, how much tax they pay will depend on their individual circumstances.

Money taken out of your pension fund will become part of your estate, which will be subject to Inheritance Tax if your estate’s total is above the tax-free allowance. This is why using your equity release money before touching your pension fund, allowing it to be passed down separately from your estate, can reduce the overall Inheritance Tax owed after your death.

It's a good idea to discuss this with your financial advisor if you plan to use your released equity in this way.

Using your equity release money to give gifts

Another common use for equity release money is to provide gifts for your loved ones. These gifts might be taxable after you pass away, but on a sliding scale depending on how long before your death they were given. They will never be taxed above the 40% standard rate.

Using your equity release money for gifts will likely lead to that money being taxed at a lower rate, especially if you give it several years before your death. And you'll get to see your loved ones benefit from the money.

If you give the gift at least seven years before your death, no tax will be deducted from it regardless of your estate’s final value.

Remember, you will only see a tax benefit from gifting your money in this way if your estate is above the taxable threshold.

For example, let’s say you have a property worth £600,000 which you are leaving to your children. After your death, 40% of tax will be owed on the part of the estate that’s above your £500,000 allowance, which will work out as £40,000 of the £100,000 excess.

If you release the property’s equity, you could gift the excess £100,000 to your children several years before your death. The tax will be lower (possibly even nothing), and you will have the pleasure of seeing how they spend it.

However, bear in mind that the compound interest on your equity release loan will build over time, significantly reducing how much of your property value can be inherited. This means that while you may avoid inheritance tax, the total amount your loved ones receive could still be lower than if you had not released equity.

Interest on equity release

Equity release is not taxable, but it will still accrue interest, which will be repaid from your estate after you die.

If you are considering releasing equity from your property, make sure that you take the time to think it through and look at potential costs, which might offset the benefits of any tax reductions.

Next steps

If you want to do some further reading about equity release, here are some other articles you might find helpful.

• Is equity release safe?
• How much equity can I release?
• Remortgage or equity release?

The thoughts and opinions expressed in the page are those of the authors, intended to be informative, and do not necessarily reflect the official policy or position of SunLife. See our Terms of Use for more info.