Inheritance tax for large estates can amount to tens, even hundreds of thousands of pounds should steps NOT be taken to counter the threat of the taxman. Equity Release schemes can be used as a genuine way of mitigating these exorbitant bills charged to the beneficiaries of any large estate.
How does inheritance tax work?
Inheritance tax is charged upon the death of an individual when the government assesses the value of the deceased’s estate. The largest asset will invariably be the main residence, however also investments, chattels, 2nd properties & even life assurance policies not placed in trust. The government then deducts all liabilities such as mortgages including Equity Release plans, loans, credit cards etc.
Should the net figure exceed the current £325,000 inheritance tax (IHT) threshold, then there will be tax charged at 40% on any amount in excess of the £325,000. This bill is then charged to the beneficiaries of the estate who must the pay this bill BEFORE any assets can be sold to pay it! This is the conundrum associated with IHT, as how can the bill be paid without selling assets first?
How can Equity Release reduce my tax bill?
As previously discussed, Equity Release schemes are a loan of last resort once all other avenues have been discussed. The same applies to IHT planning as there are other ways to reduce the bill such as using the annual IHT gift exemption of £3,000, gifts to charities, use of trusts, tenancy in common, gifts in consideration of marriage & an annual gift of £250 to anyone you know.
However, these kinds of gifts only make a small reduction in the overall tax bill, when the size of the IHT problem maybe more substantial. Additionally, gifting outside the aforementioned allowances, only becomes exempt once the individual gifting the money has lived for seven years following payment of the gift.
As clarified, all debts will be deducted from the value of the estate and thereby reduce the inheritance tax bill. Individual’s with IHT bills have therefore considered Equity Release schemes as a way of gifting money to the children now. Gifting via Equity Release will effectively reduce the tax bill due, as long as the individual gifting survives for 7 years thereafter.
The effects of Equity Release on the deceased’s estate
The reason why Equity Release operates as an effective inheritance tax reduction vehicle lies in the way this home equity loan rolls-up over the individual’s lifetime & gets bigger. It could be said that this could be countered by the house price escalating, however with the Equity Release balance getting larger it would mean a larger deduction from the value of the assets of the estate. The larger the debts, the greater the deduction & consequently the lower the excess will be over the £325,000, resulting in tax charged on 40% being reduced too.
Therefore, using Equity Release as an IHT planning vehicle works effectively & is a valuable way of transferring some of your estate now to help the children, whilst at the same time helping lower their ultimate tax bill to the government. Equity Release schemes should not be used in isolation to solve any IHT problem but be considered in an overall inheritance mitigation exercise as alternatives do exist. Therefore, at Relaxed Retirement we advocate that any potential Equity Release application should only be pursued following consultation with an IHT specialist.
Further information on Equity Release & IHT
Please call the Relaxed Retirement team on Freephone 0800 062 2563 to understand more about how Equity Release can be used to reduce a potential inheritance tax bill.