Do you pay tax on equity release?
Equity release is tax free, meaning you will not be required to pay income tax or capital gains tax on the money you release. The cash can be used as you wish and releasing equity from your home can actually reduce any inheritance tax liabilities your beneficiaries may face.
However, although you don’t pay tax on equity release, there are tax implications to be aware of and other considerations such as the amount of interest you pay.
Equity release tax implications
The money you release with a lifetime mortgage, which is the most popular type of equity release is tax free but what you choose to do with the cash you release could have tax implications. Let’s take a closer look:
You are exempt from paying income tax on equity release as the money you release is a loan and not income. However, any gains you make from the money, perhaps by putting it in savings, investments or an annuity could be subject to tax if you have exceeded your tax free personal allowance.
If you are considering equity release as an income or to increase your retirement funds, it could be worth choosing a drawdown lifetime mortgage which lets you release tax free cash as and when you need it. This may prevent any future tax implications you may have faced by keeping the money in a savings account. Also, you won’t incur interest on the money held in reserve, only the cash you have drawn down.
Capital gains tax
Capital gains tax is usually associated with the profit you make when selling a property, although your main residence is exempt as it is protected by private residence relief. Therefore, as the money you release is a loan, you do not pay capital gains tax on equity release.
Inheritance tax and equity release
Equity release can reduce inheritance tax (IHT) as it reduces the value of your estate. Currently inheritance tax is payable on estates valued above IHT threshold of £325,000 for individuals or £650,000 for couples (not taking into account the nil rate band).
As long as the way you use the money reduces the value of your estate, such as paying for a holiday, gift or experience and doesn’t increase its value, any IHT liability will be reduced.
IHT Example with no equity release
Let’s say your property is worth £600,000 and you have £100,000 in other assets. Therefore your total estate is worth £700,000. You also have no existing mortgage.
Estate worth £700,000 minus the basic threshold of £325,000 = £375,000.
Inheritance Tax is at a rate of 40%.
An IHT bill of £150,000 will need to be paid.
Alternatively if you are leaving your estate to your children the IHT threshold increases to £500,000: estate worth £700,000 minus the £500,000 threshold = £200,000.
An IHT bill of £80,000 will need to be paid.
IHT Example with equity release
We will use the same details as above, but with an average sized lifetime mortgage (Equity Release Councils Q1 2023 figures) of £102,405 on your property, which in this example you have for 15 years at an interest rate of 6.2%, the effect of compound interest will mean that you owe £258,926.
Estate value £700,000 less the outstanding amount on your equity release loan of £258,926 = £441,074
Reduced estate value now £441,074 minus the basic threshold of £325,000 = £116,074.
Inheritance Tax is at a rate of 40%.
An IHT bill of £46,430 will need to be paid, so a saving of £103,570 compared to the example with no equity release.
Once again if your estate is left to your children the IHT threshold is £500,000, so there will be no IHT to pay, a saving of £80,000.
Are gifts you buy with equity release tax free?
Using equity release as a living inheritance or to buy gifts for family and friends is tax free and will reduce inheritance tax, as long as you do not die within 7 years of giving the gift. If you are above the IHT threshold and die within 7 years of making the gift, your estate will be taxed on a sliding scale often referred to as ‘taper relief’.
|Years between gift & death
||Rate of tax on the gift
|3 to 4 years
|4 to 5 years
|5 to 6 years
|6 to 7 years
|7 or more
Using equity release to protect your pension
Another way of using equity release to reduce your tax liability is to use the money you release for day to day living costs, leaving the money saved in your pension pot untouched.
Money you withdraw from your pension may be subject to income tax, however the pension pot itself does not form part of your taxable estate so is exempt from IHT. Therefore, you could use equity release to fund your retirement, leaving your pension pot in place to pass on tax free to your beneficiaries.
Equity release, inheritance tax implications and other considerations – Important to know
If you are considering equity release as part of your estate or tax planning, it is important to seek advice from a qualified pension or estate planner who can review your personal situation and provide the best advice.
Also keep in mind that although equity release is tax free, compound interest is added to the loan and will need to be paid from your estate when you die or move into long-term care.
What should I do now?
If you are ready to speak to someone about equity release and talk through your options, help is available.
Our equity release help and advice guide explains the options available to you with top on how to make the right decisions.
Alternatively, if you would like to see how much equity you could release from your home, our calculator is free, quick and easy to use.
Or if you’re still uncertain, you may want to consider the pros and cons to help you decide if releasing equity is a good idea for you.