For many homeowners, a significant portion of their wealth is tied up in their property. As property values increase over time, it is natural to start thinking about what that might mean for your family in the future, particularly when it comes to Inheritance Tax (IHT).
One option that is often considered by homeowners is equity release. These products can offer a way to access some of the value in your property for homeowners aged 55 or over, while also potentially reducing the size of your estate.
In this article, we explain how equity release works, how the additional equity released to you can be used to potentially reduce your estate and IHT liability, and the key things to consider before proceeding with equity release.
What is equity release?
Equity release refers to a range of financial products that allow homeowners aged 55 and above to access some of the value tied up in their home without needing to sell or downsize their property.
The most common type is a lifetime mortgage, where:
- You borrow money secured against your property.
- You retain ownership of your home.
- Interest is usually added to the outstanding balance over time.
- The funds released are typically repaid when you pass away or move into long-term care.
Some plans allow you to make repayments towards the outstanding balance, while others allow the interest to roll up over time, meaning the amount owed may increase if no repayments are made.
Unlike standard mortgages:
- There are no affordability checks.
- Monthly repayments are often optional.
- The products tend to not have a fixed end date.
Because of this, equity release is often considered by homeowners later in life when a significant amount of equity has been built in the property.
How does the equity in my property increase?
Equity may increase due to two main factors:
- As you pay down your outstanding mortgage balance through monthly repayments, the portion of the property that you own will increase.
- Your property may increase in value over time due to several factors (e.g. the housing market grows or you renovate). As a result, your share of the property will increase, leading to your equity growing.
What is Inheritance Tax and how may my beneficiaries be affected?
Inheritance Tax is a tax that may be charged on the value of your estate when you pass away. Your estate consists of everything you own, including:
- Property.
- Savings.
- Investments.
- Other assets (e.g. cars or jewellery).
If the total value of your estate exceeds the Inheritance Tax thresholds applicable to you, the portion over the threshold will be subject to Inheritance Tax (current rate of 40%), before it is passed on to your beneficiaries.
What are the current Inheritance Tax thresholds?
Before exploring how Inheritance Tax may apply, it is helpful to understand the key thresholds and allowances currently in place for the 2026/27 tax year.
- Nil Rate Band (NRB)
This allowance is currently £325,000 and is the portion of your estate that can typically be passed on without Inheritance Tax being applied.
- Residence Nil Rate Band (RNRB)
The RNRB provides an additional allowance of up to £175,000 when your main residence is passed on to direct descendants (e.g. children or grandchildren).
When these allowances are combined, each individual may be able to pass on up to £500,000 free from Inheritance Tax. If you are married or in a civil partnership, this figure can potentially increase to £1 million if you combine each spouse’s allowances.
However, any value above the available thresholds is typically subject to Inheritance Tax at a rate of 40%. Additionally, the Residence Nil Rate Band is gradually reduced for estates valued above £2 million, decreasing by £1 for every £2 over this threshold.
It is important to note that from April 2027, pensions will also be included as part of your taxable estate. This makes Inheritance Tax planning and regular reviews with a financial adviser essential to help ensure your estate planning strategy is inclusive of upcoming legislative changes and remains tax efficient.
Why might equity release help reduce an Inheritance Tax bill?
In essence, Inheritance Tax is based on the net value of your estate. This means the total value of everything you own, minus any debts or liabilities (e.g. outstanding mortgage, credit, or loans).
Equity release may affect your estate in several ways:
- Your outstanding mortgage balance increases.
When you take out a lifetime mortgage, the loan (plus any interest) is secured against your property. This means the amount owed is deducted from your estate, which will reduce the net value of your property.
So, while your property may still be worth the same amount, the net value of that asset is lower due to the higher borrowing against it.
For example:
- A home worth £500,000 with no borrowing would form part of your estate at full value.
- However, if £100,000 is released, the net value will reduce to £400,000 (before interest).
As interest accrues over time, the amount owed can increase further, which may reduce the value of your estate further.
- Turn property value into accessible cash.
Equity release converts some of your property wealth into cash. What you choose to do with those funds plays a significant role in how this may affect your estate.
- If the funds are gifted:
Some people choose to pass the money on to family members as a gift. Depending on how long you live after making the gift, it may no longer be counted as part of your estate due to the seven-year rule.
- If the funds are spent:
If the money is used during your lifetime, for example to financially support your lifestyle (e.g. holidays or experiences) or loved ones (e.g. a house deposit), it will no longer form part of your estate.
- If the funds are retained:
If the funds remain in your bank account, savings, or investments, it will usually still form part of your estate. In this case, there may be little to no reduction in your overall estate value, despite the increased borrowing.
Due to this, it is not the act of releasing additional funds that may have a beneficial impact on your estate, but rather what you choose to do with the funds released to you.
Can making gifts from my released equity affect Inheritance Tax?
Yes, gifting is one of the most utilised strategies for reducing the value of an estate which may help reduce your Inheritance Tax liability.
If you gift money from equity release:
- It may fall outside of your estate if you live for seven years after making the gift.
- Smaller or regular gifts may fall within available allowances, meaning they are exempt.
- If you pass away within seven years (known as the seven-year rule) the gift may still be taken into account when calculating Inheritance Tax.
In some cases, larger gifts may still become more tax-efficient over time due to tapering rules.
Due to this, equity release is often considered alongside gifting strategies to gradually reduce the value of an estate. However, professional guidance is essential to ensure this product for your current circumstances and long-term financial objectives.
What are the current gifting allowances?
Each tax year, you can gift up to £3,000 (known as your annual gifting allowance), which can be split between one or multiple people. You can also make smaller gifts of up to £250 per person to as many individuals as you like, provided they have not also received part of your £3,000 allowance.
These gifts will not be included in the value of your estate for Inheritance Tax purposes, provided that any gifts you make are in line with HMRC’s rules on gifting.
What are the key considerations of equity release?
While equity release can be beneficial in some situations, it is important to consider the potential long-term impacts, including:
- Cost and compounding.
With lifetime mortgages, interest is typically added to the loan rather than being paid monthly. Over time, this means interest is charged on both the original amount borrowed and the interest already added. As a result, the total amount owed can increase significantly over time. This can reduce the amount of equity remaining in your property and, ultimately, what is passed on to your beneficiaries.
Interest rates for equity release products also tend to be higher than standard residential mortgage rates, which further contributes to the overall cost of an equity release plan.
- Fees.
There are several costs that you may incur from setting up an equity release plan. These may include:
- Advice fees.
- Legal fees.
- Property valuation costs.
- Lender arrangement fees.
These costs typically range between £2,000 to £3,500, depending on the provider and the complexity of the arrangement. While some products allow fees to be added to the loan, this can further increase the overall amount owed over time.
- Existing mortgage.
If you have an outstanding mortgage, it will typically need to be repaid before an equity release plan can be put in place.
In practice, this often means that part of the funds released will need to be used to clear the outstanding mortgage balance, often as a requirement of the arrangement. This reduces the amount of equity available to you and should be factored into any planning, particularly where the aim is to gift funds to loved ones.
- Impact on your estate if plans change.
The impact on your estate depends on what you choose to do with the funds after they are released to you, for example:
- If gifted funds are not structured in compliance with HMRC’s rules, they may still be counted as part of your estate.
- If your circumstances change, you may need to retain or redirect the funds.
- If you choose to retain the funds (e.g. in a bank account or savings account), they will be counted as part of your estate.
This makes looking at equity release as part of a broader plan, rather than a standalone decision, essential to ensure you do not negatively impact your day-to-day finances or long-term financial goals.
How can Cooper Associates Mortgages help?
Equity release is a significant, long-term financial commitment that can impact both your future financial position and what you leave behind for your loved ones. Because of this, it is important to fully understand how it works and how it fits into your wider plans.
Our specialist advisers provide tailored, holistic advice and will take the time to understand your circumstances, explain your options clearly, and help you explore what this could look like for you before any decisions are made.
If you would like to understand whether equity release could be appropriate for you, get in touch today to arrange a fee-free, no-obligation consultation.
