If your estate is worth more than the Inheritance Tax (IHT) nil-rate band, currently £325,000, your estate may be liable to pay IHT. Of course, you can employ exemptions and allowances to reduce or mitigate your exposure to IHT. The most obvious example is that there is no IHT liability for any transfers between spouses or civil partners. That means there are no IHT implications if your entire estate is transferred to your spouse or civil partner when you die. However, you might be simply stoking up trouble and a significant liability for the estate of your spouse or civil partner when they die.

Estate planning is essential to reduce your exposure to or mitigate the impact of IHT on your estate.

What is estate planning?

Estate planning involves managing your property, assets and investments during life to reduce or mitigate against IHT on your death. This means making plans for the destination of your property, assets and investments during life and on death in such a way that it protects these from being included in your estate for IHT purposes.

Usually, one of the high-value assets in any estate is your interest in the family home. Unless this is being left to your spouse or civil partner and your estate is in excess of the nil-rate band, it will be included in the IHT calculations.

Several options for dealing with the family home can help reduce exposure to IHT, one of which is unlocking the value of your home during your lifetime through equity release.

Can you use Equity Release in estate planning?

Equity release is an option in estate planning. When you enter into an equity release scheme, you exchange an interest in your property for cash, which you can then spend or give to family and friends. The equity release process either removes all or part of your property from your estate through a home reversion plan or creates a loan over your home as a lifetime mortgage. When conducting your estate planning, it is essential to understand the different types of equity release plans.

The two types of equity release

The two main types of equity release schemes are the home reversion plan and the lifetime mortgage. Each has its own features and a different impact on your estate.

Home reversion plans

The home reversion plan involves transferring all or part of your property to the equity release lender in exchange for a cash sum or regular payments. You need to be aware that this type of equity release scheme removes all or part of your property from your ownership. So, if you transfer your entire property to the equity release provider, it will no longer form part of your estate because you no longer own it. You will have received a cash lump sum or regular payments, which will form part of your estate unless you’ve spent or given away that money. If you invest it, any investments will be included in your estate.

Lifetime mortgage

A lifetime mortgage differs from a home reversion plan because you retain property ownership. You can either pay interest every month or allow the interest to roll up and be added to the amount released to you. When you die (or if you own the house jointly, when the last one of you dies), the house is sold, the equity release company is paid off, and any surplus is included in your estate. As with the home reversion plan, the cash lump sum you receive will form part of your estate unless you’ve spent or given away the money. Again, any investments will be included in your estate if you have invested the money.

If you decide to use equity release to unlock the capital in your home and then make a gift of some or all the money to your children, if you survive for at least 7 years, the money you’ve given away will no longer form part of your estate. If you die within that time, your estate will be entitled to taper relief.

Taper Relief (the 7-year rule)

Commonly known as the 7-year rule, taper relief applies to gifts you make to others, and when you survive for seven years or more, the value of the gift is not included in your estate for IHT purposes.

These types of gifts are called potentially exempt transfers.

Potentially exempt transfers

Potentially exempt transfers are transfers out of your estate which may be exempt from IHT. The reason for this is that should you die within seven years, the value of the gift will be subject to IHT. The rate of IHT your estate will pay depends on the time between the gift being made and your death. The rates are shown in the following table:

If you die between the first and third year from the date of the gift, the IHT rate payable on the value of the gift will remain at 40%.

It is essential to note that if you retain a benefit in the gift you’ve made, this may be considered a gift with reservations.

Gifts with reservations

A gift with reservation is a gift made to someone but where the person making the gift retains the enjoyment of the gift. A typical example of a gift with reservation is when a parent gifts the family home to their child but continues to live in the house. Unless the parent pays market rent and maintains the property, this arrangement will likely be considered a gift with reservation. The value of such gifts is included in the estate for IHT purposes, and the 7-year rule does not apply.

Using the proceeds of equity release to reduce your IHT liability

The benefit of using equity release to reduce your exposure to IHT is that it allows you to remain living in the house and turning your locked-up capital into cash. If you then decide to gift all or some of that cash to your children, when you then survive for at least seven years, you will not face an IHT liability on the amount gifted.

However, you need to be aware that whilst equity release will reduce the value of your estate, you will not realise the full value of your home through the equity release process. This means that you only receive a percentage of the value of your home through the equity release process.

You should only consider using equity release as part of a broader estate planning exercise.

Wills, Powers of Attorney and Estate Planning Solicitors, North Berwick, Dunbar, East Lothian

Our solicitors at Paris Steele have expertise in advising clients on Wills, Powers of Attorney and Estate Planning for our clients in North Berwick and Dunbar, East Lothian and across Scotland. If you would like to discuss whether you should use equity release as part of the estate planning process or would like to make or review your Will as part of your estate planning, please get in touch with us.