Planning ahead: Equity Release and Inheritance Tax (IHT) 

Each year, billions of pounds are collected by HMRC in inheritance tax, and with property prices continuing to rise and the inheritance tax thresholds frozen until at least April 2026, there will be an increase in the number of estates liable for inheritance tax. As a result, more and more people are looking to equity release as a solution to reduce the amount their estate will be taxed.  

What is Equity Release? 

Equity release allows homeowners aged 55+ in the UK access tied up equity from their home in the form of tax-free cash. There are two main types of equity release, lifetime mortgages and home reversion plans.  

A lifetime mortgage involves taking out a loan secured against the property while retaining ownership. Your lifetime mortgage will be repaid, in addition to any interest that has accrued over time, when the last applicant passes away or moves into long-term care. 

In comparison, a home reversion plan involves selling part or all of your home to a provider whilst remaining in the property rent-free. When you pass away or move into long-term care, the provider will reclaim the percentage sold at market value, often through the sale of your home.  

If you’re considering planning ahead for inheritance tax and exploring your options to reduce your inheritance tax bill, in addition to release funds from your home to use as you wish now, equity release could be an option to consider.  

What is Inheritance Tax (IHT)? 

Inheritance tax is a tax on the estate (including all property, possessions and money) of someone who has died, this is also applied to lifetime gifts made in the 7 years before death. Everyone has the same basic tax-free allowance before they must pay inheritance tax, this is known as the nil rate band (NRB), which currently stands at £325,000*. 

Whilst inheritance tax can feel complicated, our advisers have outlined some of the key rules to help you get started in understanding how inheritance tax might affect your estate and the impact equity release can have on your inheritance tax bill. It is important to understand how released equity is treated in terms of tax liabilities, particularly when it comes to gifting the funds and how it can potentially reduce the taxable value of an estate. 

Inheritance tax rules 

Inheritance tax is a tax on the estate of someone who has died, including the value of any lifetime gifts made in the seven years before the individual’s death. Inheritance tax will need to be paid if your estate is worth more than £325,000 or if you have given gifts and pass away before 7 years have passed.  

You will usually not need to pay any inheritance tax if:  

• Your estate is valued below £325,000 
• Everything above the £325,000 is left to a charity, spouse, civil partner or a community amateur sports club 

Inheritance tax is typically charged at 40% on anything above your threshold, which is £325,000 as standard with no exceptional circumstances. For example, if the value of your estate is £400,000, your estate would be charged 40% on £75,000 (£400,000 minus £325,000).  

Factors that may impact your tax-free threshold include:  

• Leaving your property to your children or grandchildren 
• If your home qualifies for the residence nil rate band (RNRB) 

Please note your estate’s value may still need to be registered, even if it is below the tax-free threshold. For a full breakdown of the latest inheritance tax rules, visit the Gov.uk website.  

Inheritance Tax Threshold 

The inheritance tax threshold is the amount above which inheritance tax is payable. For the 2024/25 tax year, the standard nil-rate band is £325,000. This means that if the value of your estate is below this amount, no inheritance tax is due. 

In addition to the standard nil-rate band, there is an additional residence nil-rate band of up to £175,000 available for those passing on their main residence to direct descendants, such as children or grandchildren. This means that a property worth up to £500,000 could potentially be passed on without incurring inheritance tax, provided it meets the criteria. 

By understanding these thresholds and planning accordingly, you can take steps to minimize the inheritance tax liability on your estate. 

The 7 Year Rule or Potentially Exempt Transfer (PET) 

No tax is due on any gifts you give if you live for 7 or more years after giving them – unless the gift is part of a trust. This is known as the 7-year rule or Potentially Exempt Transfer (PET). If you die within 7 years of giving a gift and there’s inheritance tax to pay on it, the amount of tax due after your death depends on when you gave it. 

Taper Relief 

If someone dies within 7 years of giving a gift (including property, possessions and money) that is over the tax-free threshold, the amount of tax due after their death depends on when it was gifted. Gifts given in the 3 years before your death are taxed at 40%. Gifts given 3 to 7 years before your death are taxed on a sliding scale known as ‘taper relief’: 

It is important to carefully consider inheritance tax planning to help you to pass as much of your estate to loved ones as possible, whilst maintaining flexibility and control over any arrangements made. 

If you’re thinking about releasing equity from your home, contact our qualified equity release advisers today. 

Main Residence Nil Rate Band (MRNRB) 

If you leave your home to a direct descendant – either a child or grandchild – you can benefit from an additional tax-free allowance, which currently stands at £175,000, assuming your estate is worth up to £2m. 

Spouse Exemption 

Transfers between married couples and civil partners are not subject to inheritance tax. In this scenario, if the first partner to die leaves their entire estate to the other, no tax will be payable.  

In addition to this, the remaining spouse can apply any unused inheritance tax allowance to their own estate. I.e. Increase their existing £325,000 nil rate band + £175,000 main residence nil rate band allowance by a further £325,000 NRB + £175,000 main residence nil rate band to give a total tax-free allowance of £1,000,000 when they die. 

Estates Worth Over £2m 

If your total estate is worth more than £2m, the main residence nil rate band tapers off. Falling by £1 for each £2 above the threshold. Put simply, if your estate is worth £2.4 or above in the 2022-23 tax year, you’ll lose the entire main residence nil rate band*. 

Calculating Inheritance Tax Liability 

To calculate inheritance tax liability, you need to determine the value of the estate and subtract any tax-free allowances. The value of the estate includes the value of all assets, including property, investments, and cash. Tax-free allowances include the standard nil-rate band and the residence nil-rate band. 

If the value of the estate is above the threshold, inheritance tax is payable at a rate of 40%. For example, if the value of your estate is £500,000 and you qualify for both the standard nil-rate band and the residence nil-rate band, your taxable estate would be £500,000 – £500,000 = £0, meaning no inheritance tax would be due*. 

By carefully calculating your inheritance tax liability and exploring options like equity release, you can take steps to reduce the tax burden on your estate and ensure more of your wealth is passed on to your beneficiaries. 

Reducing Inheritance Tax Liability 

Using equity release for inheritance tax planning can help reduce the value of your estate, potentially minimizing your inheritance tax liability. 

Releasing equity can provide funds to cover inheritance tax liabilities, allowing individuals to unlock the value in their property without having to sell it. This can reduce your inheritance tax bill whilst still being able to the cash tied up in your home  

Gifting equity release funds can also be an effective way to reduce inheritance tax liability, as long as the donor survives for seven years after making the gift. 

Reducing your inheritance tax liability with equity release 

Releasing money from an estate lowers the value and therefore reduces inheritance tax to be applied. A lifetime mortgage is a form of Equity Release which could be used to release money tied up in your home that would naturally contribute towards your estate and inheritance tax. 

There is no set term or repayment dates for a lifetime mortgage, the loan plus interest continues until the equity release plan comes to an end in later life which is usually when you pass away or move into long-term care. At this point, the debt has to be repaid, the original sum borrowed plus any interest accrued and fees added. This is usually from the sale of the property. 

In a recent case study, read how one of our customers used a Lifetime mortgage to fund their grandchildren’s private education and potentially reduced their Inheritance Tax liability. 

Protecting your family’s inheritance 

Equity release can be a way to reduce the inheritance tax your estate will pay in the future, but what about the inheritance you still want to leave for your family or friends?  

Some equity release plans will allow you to protect your family’s inheritance through ring-fencing part of your estate, so you can move forward knowing you are able to leave your family something for the future.  

Speak to your local equity release adviser to learn more about protecting your family’s inheritance in equity release plans.  

What happens if you inherit a house with equity release? 

If you inherit a house with an active equity release mortgage, the executor of the estate will need to repay the lifetime mortgage and interest. This may need to be done through the sale of the house, in which case you will be entitled to any proceeds left from the sale. 

Equity release lenders often allow a grace period of up to 12 months to arrange the repayment of the plan, however interest will continue to accrue during this time. 

Learn more about what happens to equity release on death.

Common Mistakes to Avoid 

Planning ahead and preparing for inheritance tax can be straightforward, unfortunately without the right guidance, it can be easy to make some mistakes along the way.  

The most common mistakes to avoid when considering equity release to assist with inheritance tax planning include:  

• Failing to seek advice about inheritance tax planning. This can lead to costly mistakes and unintended tax liabilities. Financial advice can help you see the bigger picture, considering the impact of equity release and what your inheritance tax bill might look like under your current circumstances.  
• Not considering the impact of equity release on means-tested benefits. This can also have negative consequences in the future. All reputable, independent equity release advisers should discuss the impact of equity release on your means-tested benefits including universal credit and pension credit.  
• Not reviewing and updating your will and estate plan after releasing equity. This can lead to unintended complications and consequences in the future when your estate is due to be distributed between beneficiaries.  

Planning ahead doesn’t need to be difficult with the right advice. At Bower Home Finance, we will always recommend you seek financial advice before making any decisions. Our independent financial advisors offer no obligation advice to help you move forward with confidence. Get started and request a callback from our equity release specialists today.  

Equity release advice tailored to you 

Equity release can be a valuable tool for managing inheritance tax liabilities, but it’s essential to seek professional advice and consider the potential tax implications. By understanding the basics of inheritance tax and equity release, you can make informed decisions about your financial planning and reduce your inheritance tax liability.  

Get started today and calculate how much equity you could release from your home with our free online equity release calculator.  

FAQ’s

*All data shown above correct at the date of publishing (04/03/2025)