Equity Release to Reduce Inheritance Tax | Example

Inheritance tax has long been a burden on families looking to pass the fruits of their life’s work to their heirs - once the tax-free threshold has been passed, a full 40% of the remaining estate goes to HMRC.

With property values rising and recent government policy changes squeezing tax reliefs, more estates are finding themselves within the sights of inheritance tax.

With a significant amount of savings tied up in your home, it becomes a difficult quandary - how is possible to minimise the tax impact while keeping your family home and avoiding the pressure to downsize?

An innovative solution comes through equity release and the power of a lifetime mortgage.

By using lifetime mortgages to unlock the capital held in the property, it can be passed on to heirs early and reduce the value of taxable assets. This article and our recent case study below show how it's possible to apply this approach to great effectiveness.

The Problem of Inheritance Tax Rules

Inheritance tax (IHT) is set to 40% of the value of an estate above the nil-rate band, currently set to £325,000. A further main residence allowance of £175,000 also applies when you pass on your family home to descendants, bringing the relevant tax-free level to £500,000.

However, with the IHT thresholds frozen to 2030 as part of the UK government’s latest budget, the continued rise of property prices means more and more people will find their homes passing the limit.

Other recent policy changes add additional complication to the calculations:

• Agricultural and Business Property Relief - From April 2026, a previous 100% tax relief will become capped at £1 million, with relevant property above this new threshold liable to taxation.

  
  

• Pension Funds Included in the Estate - From April 2027, unused pension funds and death benefits are to be calculated as part of a person’s estate, increasing IHT liabilities.

The need for proactive inheritance tax planning is growing, as new government changes and the ongoing freeze of the nil-rate band push more and more families into the position where IHT impacts your financial legacy.

One solution that people are exploring is gifting away wealth before it's inherited, making use of the seven-year rule (money and assets gifted away are deemed completely outside of your estate after seven years). However, most people have their wealth tied up in their pension, which is taxable to draw down, or their property, which is an illiquid asset.

The Power of Equity Release

Lifetime mortgages, traditionally used to provide funds for pensioners looking to release capital tied in their home, can provide a potential answer.

This form of equity release provides tax-free cash by leveraging the property in a unique loan structure that doesn’t require regular repayments and contractually guarantees the right to remain in the property until death.

There are very few limitations on the use of the funds provided through a lifetime mortgage, and they are free to use as a gift to reduce the taxable estate.

For IHT planning, lifetime mortgages offer three key benefits:

• Any money gifted is exempt from IHT after seven years (and taxed on a sliding scale before that time).

  
  

• The mortgage itself, including all accrued interest, reduces the value of the estate. This lowers the IHT liability, even potentially taking the estate value to below the £500,000 threshold.

  
  

• There's no need to sell your family home to gift your money to your family. 

The obvious downside is that, like any loan, there is interest to pay on a lifetime mortgage.

However, in many cases that cost is far outweighed by the tax savings, and also the effects of maintaining your foothold in the property market over numerous years.

The case study below exemplifies this in more detail: 

Case Study: Using a Lifetime Mortgage to Reduce IHT Liability

A client approached Clifton Private Finance seeking a solution to mitigate the IHT liability on his £1.5 million property.

He was 75 years old and in addition to the home, had £50,000 in savings and a monthly pension income of £5,000. In total, his estate faced an IHT bill of £420,000.

Working with our specialists, the client released £400,000 through a lifetime mortgage on his property. which was gifted to his son.

After seven years, this gift becomes exempt from IHT and saves £160,000 from the potential IHT (inheritance tax) liability.

Additionally, the interest on the loan (accruing at 6.57% pa) further reduces the estate and the IHT liability.

A projection for 15 years shows:

• A total IHT saving of £427,200 - £160,000 from the gifted funds, and £267,200 from the reduced taxable value of the estate due to the interest from the lifetime mortgage.

  
  

• Significant property value increases projected for both the original property, plus an additional property bought by the son with the £400,000, significantly outpacing the interest cost of the loan.

  
  

The Long-Term Benefits of Equity Release

Utilising equity release in this manner isn’t just an effective way to lower the inheritance tax bill - it also provides all the core benefits of a lifetime mortgage. Funds made available thanks to the equity release can be used for many purposes.

In the case study above, the client’s son used the £400,000 that was given to him to purchase an additional home. The financial benefits of this are detailed in the case study, showing the growth on a £400,000 property over 15 years; however, it is important not to dismiss the other real-world benefits of being able to buy a home.

In this example, the funds tied up in the original family property were efficiently leveraged to provide security and stability for a younger family.

The principle of the time value of money (TVM) is a key financial theory that dictates that having money today is it more valuable than the same amount in the future, due to inflation and the power of investment. It’s found in the phrase ‘a pound today is worth more than a pound tomorrow’, and historically in the saying ‘a bird in the hand is worth two in the bush’.

By leveraging the equity tied up in the family property, the time value of money can be used effectively to improve fortunes - as well as avoid the problems of downsizing or selling important assets. 

Key Considerations for Equity Release

Lifetime mortgages are a powerful tool, but using them successfully needs careful planning and a deep understanding of the finer nuances.

With the interest on the loan compounding year-on-year, and market fluctuations that can affect the value of the property, expertise in evaluating the variables is essential to avoid making a mistake.

Recent changes to IHT rules show that wider economic factors can also have an impact, especially considering the long-term nature of comprehensive estate planning.

At Hilo Finance, we have the specialised skills to ensure your IHT planning is as effective as possible. Our holistic approach, assessing the full range of finance tools available, ensures that you develop a comprehensive strategy that maximises impact and minimises taxation.

We work closely with your financial advisors, wealth managers, and accountants to construct the very best plan for the future.

Don’t wait to plan your inheritance tax strategy. With government policies evolving and property values continuing to rise, early proactive action is rewarded.

Contact Hilo Finance today on 0203 750 0305 to explore your options.