Page last updated – 5th March 2023
Equity Release and Taxes: A Guide
Equity release is a financial option that enables homeowners to access the equity in their homes without selling them. While it can be a useful way to access additional funds, there are potential tax implications that should be considered before proceeding.
Our comprehensive guide to equity release and taxes provides a detailed explanation of the various types of taxes that may be applicable, including income tax, inheritance tax, and capital gains tax.
We also provide examples and case studies to help you better understand each type of tax and how it may impact your specific situation. With this guide, you’ll have the knowledge and understanding you need to make informed decisions about equity release and its tax implications
If you want to learn more about equity release and how it works, we’ve put together a comprehensive guide on the topic. Our guide covers the different types of equity release, eligibility requirements, and more. It’s a great starting point if you’re considering equity release as an option to supplement your retirement income.
Equity Release and Taxes: The Types of Taxes
Income tax is a tax that is charged on the income you earn from various sources, including employment, investments, or pensions.
If you take out a lifetime mortgage or home reversion plan, the money you receive from the equity release is not considered income and, therefore, is not subject to income tax.
The reason for this is that the money you receive from an equity release is considered to be a loan, which means it is not classed as income.
However, if you invest the money you receive from the equity release and earn interest, dividends, or any other forms of income, you may be subject to income tax on these earnings, depending on your individual circumstances.
It’s important to note that while the money you receive from the equity release is not subject to income tax, it may still affect your eligibility for certain means-tested benefits.
Example: John takes out a lifetime mortgage and receives a lump sum of £100,000. He invests the money and earns £5,000 in interest over the next year. He will be subject to income tax on the £5,000 in interest.
Inheritance tax is a tax that is paid on the value of your estate when you die. The value of your estate includes all your assets such as property, savings, investments, and possessions.
When you take out an equity release plan like a lifetime mortgage, you are essentially borrowing money against the value of your property. This reduces the overall value of your estate, and therefore, the amount of inheritance tax that your beneficiaries may have to pay.
However, it’s important to note that if you take out a lifetime mortgage, the interest on the loan will accrue over time, and this can increase the amount of debt that needs to be repaid.
If the debt is not repaid before you die, it will be deducted from the value of your estate. Similarly, if you sell a portion of your home through a home reversion plan, your heirs will only inherit the remaining portion of the property, and the value of the property that was sold will not be included in the estate.
Example: Sarah takes out a home reversion plan and sells 50% of her home to the provider. When she dies, her estate is valued at £500,000, but her heirs will only inherit 50% of the property’s value, or £250,000. This reduces the value of her estate for inheritance tax purposes.
Tom is considering taking out a lifetime mortgage to supplement his retirement income. However, he is concerned about the impact on his inheritance tax liability because he wants to leave his home to his children.
Tom understands that the money he receives from the lifetime mortgage will reduce the value of his estate, potentially increasing his inheritance tax liability.
To address this concern, Tom works with a financial adviser to explore different options.
These options include gifting assets during his lifetime and setting up a trust to reduce the value of his estate.
By working with a professional, Tom can make informed decisions and create a plan that meets his specific needs and goals, while minimizing his tax liability.
Capital gains tax
Capital gains tax is a tax levied on the profit that you earn from selling an asset, such as property or investments.
If you sell your home after taking out a lifetime mortgage or home reversion plan, you may be subject to capital gains tax.
The amount of capital gains tax that you will be required to pay will depend on the amount of profit you make from the sale of the property, your tax bracket, and other factors.
It is worth noting that selling your property to pay off an equity release plan may exempt you from capital gains tax.
However, this exemption only applies if the sale price of the property is not higher than its value at the time the equity release plan was taken out.
In other words, if the sale price exceeds the value at the time of the equity release plan, you may have to pay capital gains tax on the difference.
The capital gains tax rate for residential property in the UK is 18% for basic rate taxpayers and 28% for higher and additional rate taxpayers. This rate may apply to profits made on the sale of a property after taking out an equity release plan.
Therefore, it’s important to carefully consider the potential tax implications of equity release and consult with a financial adviser or tax professional to make informed decisions.
Example: Jane takes out a lifetime mortgage and receives a lump sum of £100,000. She sells her home 10 years later for £300,000. The capital gains tax will be calculated based on the profit she made, which is £200,000. If Jane is in the 28% tax bracket for capital gains tax, she will owe £56,000 in capital gains tax.
Equity release can have an impact on your eligibility for means-tested benefits, so it’s important to understand the potential implications before making a decision. Our guide to equity release and benefits provides a comprehensive overview of the different types of benefits, eligibility criteria, and how equity release can affect your entitlement.
Strategies for Minimizing Your Tax Liability
If you’re considering equity release, there are several strategies you can use to minimize your tax liability:
Use the money for non-taxable expenses
If you use the money you receive from equity release for non-taxable expenses, such as home improvements or paying off debt, you won’t be subject to income tax on the money you receive. However, if you invest the money and earn interest, dividends, or other forms of income, you may be subject to income tax.
Example: Emma takes out a lifetime mortgage and uses the money to pay off her credit card debt. She won’t be subject to income tax on the money she receives because she used it for a non-taxable expense.
Plan ahead for inheritance tax
If you’re concerned about the impact of equity release on your inheritance tax liability, you may want to plan ahead to minimize your tax liability. For example, you could give away assets during your lifetime or set up a trust to reduce the value of your estate and minimize your inheritance tax liability.
Case study: Jack takes out a lifetime mortgage and receives a lump sum of £200,000. He is concerned about the impact on his inheritance tax liability because he wants to leave his home to his children. Jack works with a financial adviser to explore different options, including gifting assets during his lifetime and setting up a trust to reduce the value of his estate.
Seek professional advice
Working with a financial adviser or tax professional can help you understand the potential tax implications of equity release and develop a plan that minimizes your tax liability. A good adviser can help you explore different options, such as using the money for non-taxable expenses or planning ahead for inheritance tax, and develop a plan that meets your specific needs and goals.
Looking for the top equity release providers? Look no further than our page on the best equity release providers. We’ve done the research for you and have information on all the Equity Release Council member companies. Whether you’re looking for a lump sum or a drawdown plan, our page has everything you need to find the right provider for your needs.
Equity release can be a useful option for those seeking to supplement their retirement income or fund home improvements without selling their home. However, it’s essential to consider the tax implications that come with it.
Consulting with a financial adviser or tax professional can help you understand the potential risks and benefits of equity release and develop strategies to minimize your tax liability.
Remember to do your research and make an informed decision that aligns with your financial goals and needs.