Increasing numbers of older homeowners are turning to equity release schemes to unlock wealth from their properties in exchange for tax-free cash.
Over-55s withdrew a total of £824m from their property wealth in the three months to October, according to latest figures from the Equity Release Council, the trade body for the equity release sector, with 9,905 new plans agreed during this period. It is the first quarter that equity release lending has passed the £800m mark.
Here, we look at the tax implications of equity release, and what to watch out for if you’re considering this type of scheme.
How much tax do I have to pay if I release from my home?
When you unlock wealth from your home, the equity released is tax-free. However, if you go to invest that money or put it into a savings account, you may have to pay tax on any growth. It is important to understand that the rate of interest you’ll be charged on the amount you are borrowing may well exceed any interest or growth you get on money that you do not spend initially.
If you’re planning to use the money in the short-term, here’s what having it in a savings account would mean.
You can earn up to £1,000 in interest each tax year without having to pay any tax if you’re a basic rate taxpayer, known as your Personal Savings Allowance. This allowance falls to £500 if you’re a higher rate taxpayer, and there’s no allowance if you’re an additional rate taxpayer. If you’ve released a large sum from your property and have used up your PSA, it is possible to shelter some of your savings from tax by making use of your annual individual savings account (ISA) allowance.
This tax year you can invest up to £20,000 in ISAs either in cash, stocks and shares, or peer-to-peer lending, and returns will be free from income tax and capital gains tax (CGT).
If your plans are longer term, you may want to consider a drawdown equity release plans, as this type of plan enables you to release cash as and when you need it.
If you’re thinking about equity release, seek professional financial advice first, as an adviser will be able to let you know exactly what impact it will have on your tax position. Remember too, that releasing money from your home could affect any means tested benefits you’re entitled to, so again it’s vital to get advice so you know what impact it could have on you.
What about the impact on Inheritance Tax?
Releasing equity from your home may reduce the value of your estate so may help reduce any Inheritance Tax liability when you die. IHT is payable at a rate of 40% on the value of your estate that is above the current £325,000 IHT threshold, or £650,000 for couples.
Following changes to pension rules which enable you to pass on pension assets outside of your estate for IHT purposes, equity release has become an even more popular way of raising cash for retirement, so that pension savings can be left in tact to pass on to heirs.
Steve Wilkie, managing director of equity release specialist Responsible Equity Release, says:
"It's taken a while for people to get their heads around exactly what pension freedom means, but we are already starting to see the positive impact on the equity release market.
"The goal for many is to live comfortably in retirement; not to outlive their money and leave a substantial legacy to their loved ones. Now that a pension has been transformed into an asset which can be passed down, retirees can take a more holistic view of their financial situation. There has always been this mindset that you can't count the house you live in as a potential source of retirement income, that the only savings you have are those in your bank and pension. It is starting to register that anyone who owns a home bought with a mortgage has been saving throughout their lives. The difference is the money hasn’t gone into a bank but into bricks and mortar."
Thinking about equity release? Find out how much you can free up by using our Equity Release Calculator.