Tax and equity release explained

Any money you receive from equity release (also known as a lifetime mortgage or a home reversion plan) is not liable for tax, but it will accrue interest if you place it in a savings account. If you have borrowed a large sum and plan to hold this in a savings account you need to check if the interest earned will exceed your Personal Savings Allowance (PSA). If you exceed this allowance you will need to pay tax on the excess at your usual rate of income tax. If you reach your PSA limit, you can protect your remaining savings from tax up to the maximum ISA allowance permitted. Any interest earned after this will be liable for tax.

Advisers will not usually recommend releasing large sums of equity to place into a savings account, this is because the value of the money released through a lifetime mortgage is the difference in the interest cost of the mortgage compared to the interest earned in a savings account. If you take your equity release amount in a single lump sum, you will be accruing interest costs on this at a higher rate than you can earn in a savings account. A drawdown arrangement can help you to avoid this drain on the value of your equity release pot.

When you take out equity release it reduces the value of the estate you leave behind when you die. There is normally no tax to pay if your estate is below £325,000 or if you leave your estate to your civil partner, spouse or to a charity. If your estate is worth more than £325,000 you may be liable for 40% IHT on the value greater than this. More of us than ever before will potentially need to pay IHT, mainly due to rising house prices. The average house price is now £285,476 (Halifax March 2023).

If you are using equity release so you can give a cash gift to a family member you should be aware of the rules and exemptions applicable. You do get an annual limit of £3,000 for gifts that are exempt from IHT. In addition to this you can also give £1,000 per person as a wedding gift, £2,500 to a grandchild and £5,000 to a child. If you give gifts of more than £325,00 in the seven years before your death then those gifts in excess of this amount will be charged inheritance tax. There are other exemptions and allowances to reduce the impact of inheritance tax, such as the passing of property between spouses or civil partners– more information is available on the government website.

Equity release drawdown applies to lifetime mortgages only. Drawdown is when you get agreement from a lender to borrow a total amount but only actually borrow selected amounts (called draw down) as and when you need them. You only pay interest on the amount drawn down and this interest will compound over time. This means that interest is added to the amount withdrawn, then future interest is added on top and as a result your debt increases over time.

For example, you could be approved for equity release at a total of £75,000, choose to release £20,000 immediately and leave £55,000 to drawdown in the future. You would only start to accrue compound interest on the £20,000.

This offers you flexibility to access funds when needed, for example if your care needs change or to help a family member. By taking the money only as and when you need it, the overall cost of the borrowing is likely to be lower than it would be if you were to take the full amount available upfront. However, you may find the interest rate changes or is different between your initial borrowing and future drawdown amounts.