Will you be taxed heavily on your equity release funds? Is equity release tax a concern?

With record-breaking lending of £6.2bln in 2022¹, the industry has never been more popular. 

Is it worth joining the trend, or is it not worth your while because of the tax implications?

Our editorial team at EveryInvestor has researched and compiled the most up-to-date information on equity release taxation.

Therefore… 

What is the Nature of Equity Release for Homeowners in the UK?

Equity release, tailored for those 55 or older, allows you leverage your home’s value for cash, useful for various needs or desires.

It is a viable option for enhancing your lifestyle post-retirement, allowing you to release equity in a manageable way.

The process involves a loan against your home, repayable when you sell the property or from your estate, enabling you to remain in your home without immediate financial burden.

The implications of equity release on estate tax and potential tax liabilities should be considered.

What Are the Tax Implications of Equity Release in the UK?

Equity release in the UK can have various tax implications depending on the specific scheme you choose.

Primarily, the proceeds from equity release are not generally taxable.

This is because the lump sum you receive is considered a loan and not income.

However, if you invest this lump sum and generate income or capital gains, this could be subject to tax.

Further, the inheritance tax implications also need to be considered.

When your property is sold upon your passing to repay the equity release loan, the value of your estate that could be passed onto your heirs may significantly diminish.

Moreover, if the equity release increases the value of your estate above the Inheritance Tax threshold, there could be a higher tax liability.

In some cases, equity release can reduce an inheritance tax bill if it is structured correctly.

Always consult a tax advisor or financial expert before deciding on equity release.

Do You Pay Tax on Equity Release in the UK? 

No, you do not pay tax on equity release in the UK. 

In fact, an equity release lump sum can help reduce the tax you will be subject to pay on other assets in your estate. 

The tax implications will depend on how you use the cash you unlock and your other financial assets and pensions. 

It is essential to seek professional advice to ensure the best course of action for your specific situation.

Why Is Equity Release Tax-Free?

Equity release is tax-free because it is seen as a loan and not as a form of income, but remember that the loan, along with interest, will need to be repaid, potentially impacting your estate’s value. 

Interesting fact…

The same rules apply to a residential mortgage, but other factors such as interest rates, repayment terms, and overall impact on your finances can differ. 

You will not be taxed even if you use your equity release mortgage to top up your income.

Do the same standards apply to Income Tax and Capital Gains Tax?

Income Tax

As mentioned above, equity release is exempt from income tax as it is not a form of income. 

Instead, it is a secured loan against your property, even if used to supplement income. 

Capital Gains Tax (CGT)

Capital Gains Tax is due when you sell many assets and receive funds exceeding the Capital Gains Tax threshold.² 

Equity release is exempt from Capital Gains Tax because, although it provides a lump sum of cash, it is considered a loan rather than traditional income.

Remember that equity release schemes may not be suitable for everyone, and the risks involved should be carefully considered before making a decision. 

The potential downsides include a reduction in the inheritance you leave behind, the possibility of negative equity if the property value declines, and the long-term costs of interest accumulating over time.

It is also important to note that tax laws can change, so staying up-to-date and consulting a financial advisor is essential.

Read More: Is Equity Release Suitable For You?

Can Equity Release Be Used to Reduce Inheritance Tax (IHT)?

Yes, equity release could be used to reduce inheritance tax in certain instances. Still, it may also reduce the overall value of the inheritance left to your beneficiaries due to interest accumulation and fees.

This strategy may only suit some, so you must disclose the specific circumstances and consult a financial advisor to determine if this approach is appropriate for you.

If you decide to gift someone with equity release money, it will not be subject to inheritance tax if you live seven years after it was given.³

In addition, equity release decreases the value of the estate due to the principal debt and interest. 

This includes…

• Accrued / compound interest 
• The share in property appreciation 
• Equity release fees

Will My Beneficiaries Need to Pay Inheritance Tax on Equity Release Funds Received?

Yes, in some cases, your beneficiaries will have to pay inheritance tax on equity release funds received.

Important notice…

If you pass away within seven years of giving your family an early inheritance with equity release, your heirs will be required to pay tax on the funds.

Why Else Would IHT Not Be Paid?

IHT would not be paid in the following cases.⁴

• Your estate is worth less than £325,000.
• You select to leave everything above the £325,000 to a charity, community non-profit sports club, spouse, or civil partner. 

IHT Example: No Equity Release 

Inheritance Tax with no equity release would be a standard Inheritance Tax rate of 40%. 

This is only charged on inheritance, provided it is above the £325,000 threshold.

For example…

If you provide an inheritance of £400,000, your heirs will be taxed on £75,000.

Therefore, the total funds received will be £370,000 after a 40% tax reduction.

These figures are for indicative purposes only. 

IHT Example: With Equity Release

An IHT example with equity release would be relevant when you pass away within seven years of gifting the funds, which could lead to additional tax liabilities for your beneficiaries.

The amount your heirs will pay is calculated using a reducing scale, known as ‘taper relief’.⁵

The tapered relief works as follows, based on current tax laws and regulations…

• Less than 3 years since the payment = 40%
• 3 – 4 years since the payment = 32%
• 4 – 5 years since the payment = 24%
• 5 – 6 years since the payment = 16%
• 6 – 7 years since the payment = 8%
• 7 or more years since the payment = 0%

Note that these rates are subject to change and may not apply to your specific situation.

Common Questions

In Conclusion

Understanding the tax implications of equity release schemes before deciding to cash in on your home’s value is crucial.

By consulting with a financial advisor and keeping up-to-date with current tax laws, you can make informed decisions and potentially save money in the long run. 

Remain knowledgeable and secure your financial future with these valuable equity release tax tips.