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Avoid Inheritance Tax with Equity Release ?

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Is it a good idea to use equity release to reduce your inheritance tax liability . . .err maybe !!

Many companies recommend the use of equity release loans as a way of mitigating a future liability for inheritance tax. While it is undoubtedly true that an equity release loan will reduce the value of your estate and therefore any inheritance tax liability, the problem is that until you die, the exact amount of any saving (if any) is unknown. Furthermore the amount paid back to the loan provider may be more than any inheritance tax (IHT) that would have paid.

The people you leave behind may have preferred to have paid the tax on the value of the property rather than see the majority of it disappear in repayments to the equity release loan provider.

This doesn’t mean that equity release shouldn’t be used to reduce inheritance tax liability, but given the uncertainty about the future, you need to give it very careful consideration. Perhaps the simplest way of looking at it is; if using equity release now helps you to achieve very specific current goals and plans then you will just have to accept that the future inheritance tax liability will be whatever it happens to be at the time. 

Unlike some other IHT solutions, there are a number of key variables that are out of your control. These variables will have a direct impact on any saving you may make. The key variables are :

1. The date of death of the last person named on the loan – this is of course unknown.

The date of your death will determine the amount that needs to repaid at the time. Naturally most people will want this date to be many years into the future.

An equity release loan would also have to be repaid if the last named person on the loan was taken into long term care.

2. The inheritance tax threshold on the date of your death, again this is also unknown.

IHT is paid on the value of an estate which is in excess of the IHT threshold. In the current tax year (2014-15) the IHT threshold is £325,000 and tax at a rate of 40% is payable on amounts above this.  Therefore if somebody who dies has an estate (everything they own less everything they owe) of £425,000 the £100,000 in excess of the £325,000 threshold is subject to inheritance tax. In this example tax of £40,000 would be payable. If the person in this example had an equity release loan debt of £125,000 then this would bring the estate value down to £300,000 and no tax would be payable.

In the example above the equity release loan could be seen as a good thing, the customer had some extra money in their lifetime and the remainder of their estate is now not subject to inheritance tax. The amount they would repay (£125,000) to the equity release provider would be the original loan plus the rolled up interest on the loan.

However if the money was taken out of the property purely to reduce a future inheritance tax liability, then for the reasons discussed below that could be a risky decision.

It should be remembered that inheritance tax is a very unpopular tax in the UK. When the tax was originally introduced, it was aimed at families who were considerably wealthier than most people. Mainly due to property ownership - people with very modest means can now find themselves with an inheritance tax liability. There is considerable pressure on political parties and governments to take action to remove what many consider to be an unfair and punitive tax. Therefore there could be many changes to inheritance tax in the years ahead, this could include considerably increasing the threshold to remove the vast majority of people from the tax altogether; significantly reducing the percentage of tax payable and even abolishing it altogether.

It should also be remembered that to make this an effective transaction from an IHT perspective, the customer ideally needs to take the money they have taken from their property and somehow remove it from their estate. They could gift it to their family and friends but this would be classed as a Potentialy Exempt Transfer and will not be entirely free of inheritance tax for 7 years. Of course it could be great fun spending tens of thousands of pounds on holidays and other treats, but if you spend the money on classic cars, antiques or home improvements, you could inadvertently increase the value of your estate rather than reduce it.

For this reason it would equally not be sensible to keep the money in savings and investments. You can place any savings and investments in trust and thereby remove them from your estate but again any such trust would be liable to the 7 year rule.

3. While the interest rate of your Equity Release loan is known at outset, as the loan has no fixed term, therefore the actual amount of money you would have to repay is not known.

If we again use the example of somebody who takes £100,000 from their property and is able to use it in a way that it no longer forms a part of their estate. Furthermore taking this money from the property brings the value of their estate below the inheritance tax threshold. It will now depend on when they die whether this has been a worthwhile exercise from the perspective of avoiding inheritance tax. The two examples below show how the transaction discussed in this paragraph can have significantly different outcomes depending of the date of death.

If we assume that the whole £100,000 released by the customer would have been subject to IHT at current rates. This means that if the customer had died before taking out the equity release loan, £40,000 would have been paid in inheritance tax. In the first example if we assume the customer died three years after taking the equity release loan then the amount of loan to be repaid is approximately £122,0000 – this being the original loan plus interest of £22,000. In this case it would have been an excellent way of avoiding or reducing inheritance tax. The customer and their family have had the full benefit of the £100,000 three years earlier and the cost of their debt is £22,000. This is a saving of £18,000 on the amount they would have had to pay in IHT.

The second example is a little more complicated and assumes the customer lives for a further 15 years after taking out the equity release loan. To keep it simple we will assume that even though the property value is likely to grow over the 15 year period and the IHT threshold could also increase, we will assume that the equity release debt keeps pace with them. In other words the underlying value of the estate doesn’t alter. After 15 years the amount that needs to be repaid to the equity release provider is approximately £250,000.

Again while the customer and family previously had the benefit of £100,000, the costs of the loan are now £150,000. While this debt brings the value of the estate below the IHT threshold, had the customer not used equity release then the inheritance tax that would have been paid on £250,000 at 40% would have been £100,000. In this scenario the estate is £50,000 worse off.

Please don’t take the examples above to indicate that equity release is a bad way to reduce your inheritance tax liabilities. The point we are really trying to make is that for this type of planning it is a bit of an imprecise tool. Equity Release has many useful features and benefits, many plans have an income drawdown facility which will allow you to take lump sums as and when you want them. This can help minimise the impact of rolled-up interest.

Our conclusions currently are that Equity Release is best used to solve a current potential problem rather than using it to try to control events that may be beyond your control. If you can take money out of your property now and put it to good use, then perhaps that should be good enough, if you end up beating the inheritance tax system too, well then that’s a bonus !

Published : 26th November 2014
Nothing in this article should be taken as personal advice and recommendation. UK tax rates and legislation are liable to change. Products, concepts, rates, legislation and rules referred to in the article above may not be current at the time you read the article.
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