Equity release and inheritance – how does it work?

Explore equity release and inheritance protection  – plus how a plan can help reduce IHT

Written in line with our editorial policy.

It’s a common myth that you won’t be able to leave an inheritance if you arrange an equity release plan. The fact is, there are various ways in which you can ensure your family will inherit from your property if this is important to you. In some cases, equity release can even reduce the amount of inheritance tax (IHT) your estate is liable for.

To help you understand equity release and inheritance planning, we explain the following in today’s blog:

• What is equity release?
• How does equity release affect inheritance?
• What is equity release inheritance protection?
• How interest-only plans can help to protect inheritance
• Making equity release partial repayments to protect inheritance
• Impact of equity release on inheritance tax
• Could I reduce inheritance tax by gifting equity release?

We hope this guide will help to answer your questions about equity release and inheritance. Our selected advisers are also available to discuss your circumstances and offer further information and advice. Just call us on 0808 178 3055 or request a call back and we’ll arrange a no-obligation appointment for you. 

Alternatively, check your eligibility and get an initial indication of how much tax-free cash you could unlock.

What is equity release?

Equity release is a way for homeowners aged 55 or over to unlock the tax-free cash tied up in your bricks and mortar.  There are two main types of equity release plan: 

A lifetime mortgage: Release a percentage of your home’s value to spend how you wish, whilst retaining full ownership of your property. This is the most popular type of equity release plan. You won’t have to make any mandatory monthly repayments as the loan plus interest rolls up each month. If you wish, you can make voluntary payments towards your plan to reduce the interest or even pay off your overall loan over time.

A home reversion plan: This allows you to sell all or part of your home to a reversion company in exchange for a tax-free cash lump sum. You may be able to unlock more from your home with this type of plan.

With both types of equity release plan, your home is sold to repay the equity release provider when you pass away or move into long term care.

How does equity release affect inheritance?

Equity release affects the inheritance you leave because you are arranging a loan secured against the value of your home. In addition to the tax-free cash you unlock from your home, you will accrue interest which rolls up each month and adds to your overall loan amount.

When you pass away or move into long-term care, your home is put up for sale in order for your loan plus any interest to be repaid. After this is done, any money left over is paid back to you, or to your estate if you pass away.

The amount you can leave to your estate will naturally be less if you arrange a plan. However, there are ways to guarantee that your beneficiaries will still inherit something. These include inheritance protection options and making voluntary repayments on your plan.

What is equity release inheritance protection?

An inheritance protection guarantee is one of the features available with equity release. It involves ringfencing a percentage of your home’s value to ensure that your family will receive at least that amount in the future.

By building inheritance protection into your plan, you can ensure that no matter how much interest accrues on your plan, the percentage you protect at the outset is there for you or your family in the future.

When searching for the best deals for you, your adviser will ask if you want to build equity release inheritance protection into your plan. Do let them know if this is important to you.

Example of equity release inheritance protection 

A couple has a small outstanding mortgage which is eating into their pension income. They therefore choose to release some of their home’s value to pay off the mortgage and make some home improvements. 

When they arrange their equity release plan, they opt for inheritance protection to safeguard 20% of their home’s value and guarantee an inheritance for their children. This reduces how much they can unlock, but they don’t mind as leaving an inheritance is very important to them.

When their home sells after they pass away, 20% of the selling price is set aside for their beneficiaries. Depending on the size of loan and interest outstanding, there may be additional money from the sale also available to the beneficiaries.

Points to consider about inheritance protection

If you are considering equity release, and inheritance protection sounds like a good option for you, make sure you consider the following points:

• Selecting an inheritance guarantee will reduce the amount that you can borrow. This is because providers calculate your maximum loan amount based on the equity you have which is not covered by the inheritance guarantee. So if you have a £250,000 home and want to protect 20% of it for your children, the maximum you can borrow will be a percentage of £200,000, rather than £250,000.
• Future changes in house values could affect the inheritance. As you are protecting a percentage of your home’s value, do remember that if your house value decreases in the future, the value of the amount you protect will also decrease. This will reduce the amount of inheritance you leave. Of course, if your home’s value increases over time then so will the value of the amount you protect.
• You can only include an inheritance guarantee in your plan when you first arrange it. You can’t usually add inheritance protection at a later date. However, you may be able to remove it in the future should you wish to borrow more. Removing it may also reduce the amount you may have to repay if you are moving or adding someone to your plan.
• There may be a charge for inheritance protection. Some providers charge more for including an inheritance protection guarantee. This may affect the interest rate you are offered, for example. 

If you want to take out equity release and inheritance planning is a priority for you, our  selected advisers can help you. Call us on 0808 178 3055 or request a call back and we will arrange an appointment with one of our selected advisers.

How interest-only plans can help to protect inheritance

By choosing an interest-only equity release plan, you can ensure your overall loan size never increases. This will protect the remaining equity and safeguard your family’s inheritance. 

By keeping up with the monthly interest repayments on your loan, you will be protecting your home’s value from the effect of compound interest that would otherwise roll up each month. 

You can make the repayments each month for as long as you wish. If you choose to stop making the payments each month then your plan will convert to a standard lifetime mortgage. At this point the interest will roll up and add to the overall loan amount each month.

Say you select an interest-only plan for 20 years and manage to keep up with the monthly repayments for the first ten of them. By doing so, you will protect your estate from ten years of interest accruing on your plan.

This could make a significant difference to the amount of inheritance you are able to leave your family when you pass away.

Making equity release partial repayments to protect inheritance

Did you know that you can make voluntary repayments on your equity release plan each year to help protect your family’s inheritance?

All plans approved by the Equity Release Council come with the guarantee that you will be able to make penalty-free partial repayments, subject to lending criteria. At Equity Release Wise, our selected advisers will only ever recommend plans with the Equity Release Council seal of approval.

It means you can unlock the money you need and make ad hoc repayments whenever you wish, up to a certain amount each year, without incurring early repayment charges.

Some big name lenders such as Aviva allow you to repay up to 10% of your overall loan every year without penalty.

If you want to arrange equity release and inheritance is an important issue for you, this feature could be ideal for you. By making voluntary partial repayments on your plan, you help to protect the remaining equity in your home so it is available as an inheritance in the future.

You could even pay off your loan over time so that 100% of your home’s equity can be left to your beneficiaries.

Impact of equity release on inheritance tax

The amount of Inheritance Tax (IHT) your estate will have to pay will depend on its size when you pass away. Your estate is all the property, money and possessions that you leave behind when you pass away. By releasing some of the equity from your home, you are reducing the value of your estate. 

As your money cannot be taxed if you have spent it, equity release can reduce the amount of inheritance tax that your estate might have to pay in the future.  

Depending on your estate value and how much you unlock, you may even take your estate under the threshold completely. Do note though, this depends on you spending the money you release and not investing it.

Current inheritance rules mean that:

• If your total estate is valued at less than £325,000 – or £650,000 for couples – then there won’t be any inheritance tax to pay. 
• There’s no tax to pay if everything over the £325,000 threshold is left to a spouse, civil partner or charity (2022/23 tax year).
• If you are leaving your home to your children (this includes any adopted, foster or stepchildren) or to your grandchildren then your threshold can increase to £500,000.
• If your estate comes to more than the threshold then any amount above it may be taxed at 40%. 

Inheritance tax is a potentially complex subject so please make sure you are fully informed about it before committing to an equity release plan. You can read more about how inheritance tax works here, or discuss your situation with our selected advisers, who may recommend that you seek specialist tax advice. 

Could I reduce my inheritance tax by gifting equity release?

One of the main uses of equity release is for homeowners to gift their loved ones with a ‘living inheritance’ so they can see them enjoy their money now. This can make a huge difference to the lives of family members struggling to get on or up the property ladder, or living with the burden of loans or credit cards.

As we have discussed already, equity release will reduce the value of your estate, and therefore can reduce your inheritance liability. You should consider however, that if you pass away within seven years of gifting your money, your family may have to pay an inheritance tax bill. 

When you pass away, the sale of your home will typically clear your equity release loan plus interest. After this is done, if your estate is valued at more than £325,000 for a single person or £650,000 for a married couple/civil partner after the surviving partner dies, then your beneficiaries will pay tax on the amount over this threshold. This includes any money you gave away in the seven years prior to your death.

The rules regarding inheritance tax and gifting mean that:

• Gifts subject to inheritance tax include money, property, stocks and shares, valuables and more. 
• Any amount you gift will be exempt from inheritance tax if you live for seven years after.
• If you pass away within three years of making the gift, the full amount will be considered in addition to your estate when calculating your inheritance tax liability. This may mean the gift is taxed at 40% if you exceed your personal threshold.
• If you pass away between three and seven years after gifting money, then the tax due on the gift tapers so less is owed over time.
• As tax is potentially payable by the recipient of the gift, careful thought is needed before making lifetime gifts in excess of £325,000.

You can read more about the inheritance tax gifting rules here, including information on the seven year rule.

If the issue of equity release and inheritance tax is important to you, do make sure you mention this when talking to one of our selected advisers. They may recommend that you seek specialist tax advice to address issues around equity release and inheritance planning.

Speak to an equity release specialist today

To find out how equity release might work for you, speak to our friendly team on 0808 178 3055. They can connect you to one of our carefully selected advisers who can check your eligibility for a plan and obtain quotes from leading equity release providers.

You will only be charged a fee for advice if you go ahead with a plan, which can be paid from the money you release. Alternatively, request a free call back here.