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The Tax Implications of Equity Release

Last updated 28th October 2021

5 min read

You do not need to pay tax on any money you receive through equity release. An equity release lump sum could even be used in such a way as to reduce the tax you may need to pay on the other assets in your estate, depending on how you make use of the funds alongside your pension and other financial assets.

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. It is therefore exempt from the taxes that apply when you gain money through regular income or other means, such as accruing income on savings.

Income Tax

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

As well as regular earnings from a job, Income Tax can also be charged on money gained through investments and savings.

You have a tax-free allowance (your Personal Allowance) of up to £12,750 a year which does not require Income Tax. If your wages or pension do not use up this allowance, it can also count towards your savings income.

If your income from sources other than savings is less than £17,570, you gain an additional £5,000 tax-free allowance for your savings income. You can learn more on GOV.UK.

All of this means that your equity release money could lead to Income Tax if it is used in such a way that you gain income through savings, investments, dividends and the like. However, the tax will still be deducted from the additional money you gain, not the original equity release sum.

It is also important to remember that money released in a drawdown lifetime mortgage – a type of equity release that pays out in installments – is also not subject to Income Tax, despite the fact that it might feel like a regular income in practice.

Capital Gains Tax

Capital Gains Tax (CGT) is commonly associated with profits gained on 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.

In the same way that a regular mortgage loan is not subject to a tax, equity release is also free from CGT. Capital Gains Tax is only charged when an asset is ‘disposed of.’

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, 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, remember that the money being taxed in this instance is the money gained from the sale, not any part of your original equity release sum.

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Does equity release reduce Inheritance Tax?

One of the most important 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 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, civil partner, a charity or a community amateur sports club, you do not have to pay any tax. This allows married couples and civil partners to double the shared allowance for their estate. As such, if you are married or in a civil partnership the benefits of equity release on inheritance will only be seen once the estate passes to your children or another party.

In order to use 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

While money withdrawn from private pension funds is subject to Income Tax above the tax-free allowance, pension pots themselves aren’t usually part of your estate, and so don’t usually qualify for Inheritance Tax when passed on.

Some nuances apply, depending 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.

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.

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, but they are only taxed on a sliding scale depending on how long before your death they were given, and 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. Think of it as a portion of your estate being passed on at a lower tax rate rather than being taxed at 40%. 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 benefit from gifting your money in this way if your estate is above the taxable threshold.

To illustrate this point, 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.

However, 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.

Interest on equity release

Although equity release is not taxable, it will still accrue interest, which will be repaid from your estate after your death. Interest affects both lump sums and equity released over a longer period of time in drawdown plans, although it will only start to build once money is withdrawn from the latter.

If you are considering releasing equity from your property, ensure 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

You can speak to us in a free consultation if you want to learn more about equity release.

However, if you want to do some further reading before speaking to anyone directly, here are some other articles you might find helpful.

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