Vanessa Owen discusses the inheritance tax implications of using equity release
There is no doubt that attitudes towards equity release have shifted, with a growing acceptance that equity release is a legitimate, viable financial planning tool. The sea change brought about in no small part by SHIP, has navigated the industry steadfastly away from its past, by offering consumers and their advisers products they can be confident in.
But can releasing the equity in your home through the products currently on the market actually reduce the impact of inheritance tax?
Equity release products are an option that should be considered for many of the challenges that people face in retirement, and in the wider estate planning context there can be significant benefits in using equity release. But if the aim is simply to reduce the impact of IHT it can be a risky business.
Since the start of 2010, LV= has seen a rise in the percentage of applications specifically for inheritance tax planning.
Inheritance tax threshold
There has been rapid growth in UK house prices over recent years, and despite the slump in 2008, for most people their home is still their largest asset, and the one that pushes them over the inheritance tax threshold. It does, therefore, seem logical that taking money from your home and giving it away could offer a solution to this problem.
Take this example: Your client has a house worth £400,000. He releases £50,000 which he gives to his children. After 10 years the house is worth £620,000. We’ll assume that the debt to the estate from the equity release plan has doubled to £100,000. This leaves £520,000 in his estate. Assuming that the nil rate band is still £325,000, the potential IHT liability is £78,000. If your client made no other gifts, the £50,000 he gave to his children is now outside of his estate. So in total, his children receive £492,000 after the 10-year period. (That’s £442,000 in the estate after tax, plus the £50,000 gift).
If he had done nothing, the inheritance tax liability on his house would be £118,000. After tax, his children would receive £502,000, making them £10,000 better off. Or are they?
We believe that using a lifetime mortgage to simply mitigate IHT only works if the money released from the property is in turn invested to maximise growth. It’s not enough to simply advise on getting money out of the estate. This approach to inheritance tax planning only works if you can leverage for a better return once the money is released.
Going back to the example – don’t forget the £50,000 your client gave his children. What did they do with it?
The children used the £50,000 they received as a deposit on their first house. With rising property prices, 10 years on this deposit has grown to £78,000. That’s £28,000 growth outside the estate. Add this back to the remaining estate after the debt is cleared and they are actually £18,000 better off than if he’d done nothing.
But this example assumes house prices are only going up. In a falling market, releasing equity from your home for IHT planning is only going to make a bad situation much worse. Especially if the money you take out is reinvested into property as well. Effectively you are gearing – borrowing money at a certain rate and investing it to achieve greater returns, if the markets are favourable the benefit is evident, but there is a significant potential downside and great risk to this strategy.
Would you do it? Would I do it? Looking at the examples above you might think that using equity release solely for IHT purposes has a marginal benefit compared to doing nothing at all. But if a clients’ only motive for releasing the equity in their home is to mitigate IHT then I would strongly recommend against it. In many cases, such gearing of assets is a risk that may end up being of less benefit compared to leaving the equity in their home. It’s essential we understand the clients motivation to take out equity release and know they’ve weighed up the alternatives.
Vanessa Owen is head of equity release at LV=
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