Can equity release impact my tax situation?

Equity release involves unlocking wealth tied up in your property, usually through a Lifetime Mortgage (LTM) or a Home Reversion Plan (HRP). While the funds received from equity release are generally not subject to Income Tax or Capital Gains Tax (CGT) in the UK, holding these funds as savings, or reducing your estate’s value, can have profound effects on your personal tax situation and eligibility for state benefits. It is essential to understand that capital accumulated from equity release can push your total savings above the threshold for crucial means-tested benefits, potentially leading to a significant reduction or complete loss of entitlement. Furthermore, the debt incurred (in the case of LTM) or the loss of property ownership (in the case of HRP) fundamentally changes the size of your estate for Inheritance Tax planning purposes.

Understanding How Equity Release Funds Can Impact Your Tax Situation in the UK

For many homeowners over the age of 55 in the UK, equity release represents a vital way to access retirement income, clear outstanding debts, or help family members financially. Because it deals directly with substantial capital assets and debt restructuring, the financial implications are complex and stretch beyond simple repayment schedules, especially concerning taxation and state entitlements.

This guide, provided by Promise Money, aims to clarify the specific ways can equity release impact my tax situation, focusing primarily on Income Tax, Capital Gains Tax, Inheritance Tax (IHT), and the critical interplay with state benefits.

The Tax-Free Nature of Equity Release Proceeds

One of the main attractive features of equity release is the fact that the money you receive is typically free from standard UK taxes when it is released. This applies whether you choose a Lifetime Mortgage (LTM) or a Home Reversion Plan (HRP).

Income Tax and Capital Gains Tax

The funds acquired through equity release are treated as a capital transaction, not as income or earnings. This is why standard Income Tax rules do not apply:

• Lifetime Mortgage (LTM): An LTM is a loan secured against your home. The money you receive is capital borrowed from a lender; it is not earned income. Therefore, it is exempt from Income Tax.
• Home Reversion Plan (HRP): An HRP involves selling a share of your home (or the entire home) in exchange for a lump sum or regular payments while retaining the right to live there rent-free. This sale, provided the property remains your main residence (Principal Private Residence or PPR), is generally exempt from Capital Gains Tax (CGT).

It is important to note that while the money itself is tax-free upon receipt, any income subsequently generated by investing that lump sum (e.g., interest earned on savings accounts, dividends, or rental income) will be subject to standard Income Tax rules, depending on your total annual income and available allowances.

The Critical Impact on Means-Tested Benefits

While the funds are tax-free upon release, they immediately convert into capital or savings in your name. This is arguably the most significant way equity release can negatively affect your financial situation, especially for those relying on state support.

Many UK state benefits are “means-tested,” meaning eligibility and the level of support received depend on your income and the amount of capital (savings and investments) you hold. If your capital exceeds specific thresholds, your benefit payments will be reduced or stopped entirely.

Benefit Thresholds and Equity Release Capital

The rules governing capital limits are complex and vary depending on the benefit. However, the general thresholds are critical:

• The Lower Limit (around £6,000 to £10,000): For benefits like Pension Credit, Universal Credit, and Housing Benefit, if your savings exceed a lower limit (often £10,000 for Pension Credit, or £6,000 for Universal Credit claimants below State Pension age), your benefits may start being tapered down (reduced).
• The Upper Limit (around £16,000): If your capital exceeds the upper limit (most commonly £16,000), you will typically lose entitlement to most means-tested benefits completely.

If you take out a large lump sum through equity release, that money immediately counts towards your capital limit. Even if you plan to spend the money quickly, if the capital remains in your account for even one assessment period and pushes you over the threshold, you could lose crucial benefit entitlements.

Common means-tested benefits that could be affected include:

• Pension Credit (Guarantee Credit and Savings Credit)
• Universal Credit (if applicable)
• Council Tax Reduction
• Housing Benefit
• Attendance Allowance (usually not means-tested, but linked benefits might be)

Compliance Note: Before proceeding with equity release, it is mandatory to seek specialist advice to model the precise impact the capital raised will have on your current and future benefit entitlements. Failing to do this could result in a net financial loss, even with the tax-free lump sum.

Equity Release and Inheritance Tax (IHT) Planning

Inheritance Tax (IHT) is levied on the value of a deceased person’s estate above the applicable tax-free thresholds (the Nil-Rate Band, currently £325,000, plus the Residence Nil-Rate Band, if applicable). Equity release often forms part of an estate planning strategy, as it inherently alters the net value of the estate.

How Lifetime Mortgages Reduce the Estate

A Lifetime Mortgage involves taking out a loan where the interest typically rolls up over time, compounding the debt. Because this outstanding debt is secured against the property, it must be repaid from the estate after the last homeowner passes away or moves into permanent care.

For IHT purposes, the estate is calculated on the net value of assets minus liabilities. The principal loan amount, plus all accrued, rolled-up interest, constitutes a significant liability. Therefore, the total outstanding LTM debt directly reduces the taxable value of the estate.

If your estate is large and likely to face an IHT charge (i.e., significantly exceeding the Nil-Rate Band), reducing the net value through compounding debt might be a beneficial tax planning strategy.

How Home Reversion Plans Reduce the Estate

Under an HRP, you sell a percentage of your home (or the whole property) to the provider. Although you retain the right to live in the property, the portion you have sold is no longer part of your estate when calculating IHT. This is perhaps a more definitive method of reducing the estate’s value immediately for tax purposes.

Gifting Equity Release Funds and the 7-Year Rule

Many people use equity release to raise funds specifically to help family members, such as providing a deposit for a grandchild’s home. Gifting funds can be an excellent way to reduce your potential IHT liability, but strict rules apply.

Under UK IHT rules, most gifts (known as Potentially Exempt Transfers or PETs) only become fully exempt from IHT if the donor survives for seven full years after making the gift. This is often referred to as the 7-year rule (or taper relief if the deceased survived between 3 and 7 years).

If you gift a large sum obtained via equity release and pass away within seven years, that money may still be counted as part of your estate for IHT calculations.

You can find comprehensive details about the rules on gifting funds for Inheritance Tax purposes on the official government website. Understanding the PET rules, annual exemption limits, and taper relief is crucial if using equity release funds for generational wealth transfer.

Tax Implications on Property Maintenance and Repairs

While the funds themselves are tax-free, how you spend the money can sometimes touch upon tax areas, though usually minimally for homeowners.

If you use equity release funds for significant home improvements, these costs are personal expenses and cannot typically be deducted against Income Tax, even if the work increases the property’s eventual sale value. The PPR exemption usually protects the property from Capital Gains Tax regardless of improvement costs.

However, if the property is used partly for business or rental purposes, specialist advice must be sought, as tax rules around capital expenditure and deductibility can become complex.

Are Equity Release Payments Tax-Deductible?

A common question is whether the interest accrued on a Lifetime Mortgage can be offset against other income for tax purposes. The answer is generally no.

The interest paid (or rolled up) on an LTM is considered a personal debt expense, similar to a residential mortgage. Unlike some buy-to-let loans or business debts, personal interest payments are not tax-deductible against standard UK Income Tax. Therefore, the significant cost of rolled-up interest does not provide any tax advantage during the life of the loan.

Compliance and Financial Planning Requirements

Due to the irreversible nature of equity release and its deep impact on both your estate value and state benefit entitlements, the Financial Conduct Authority (FCA) mandates that anyone considering an equity release product must receive regulated financial advice.

A qualified financial adviser specialising in equity release will conduct a detailed assessment of your circumstances, including:

• Reviewing your current income and means-tested benefit entitlements.
• Projecting the impact of the capital lump sum on those benefits.
• Analysing your overall estate size and IHT exposure.
• Modelling different release options (lump sum vs. drawdown) to minimise potential tax and benefit pitfalls.

The advice provided must specifically address how the proposed plan could affect your tax position, ensuring you do not unintentionally lose a higher value of benefits than the value of the lump sum received.

People also asked

Is equity release treated as taxable income by HMRC?

No, the money received from an equity release plan is treated as a capital transaction (either a loan or a property sale) and is not viewed as earned income by HM Revenue & Customs (HMRC). Therefore, it is generally exempt from standard UK Income Tax.

Will I have to pay Capital Gains Tax (CGT) when I take out equity release?

In most cases, no. If the property remains your Principal Private Residence (PPR), any potential gain realised—either through a Home Reversion Plan sale or the eventual sale after a Lifetime Mortgage is repaid—is protected by the PPR exemption, meaning you typically will not pay CGT.

Does rolling up interest on a Lifetime Mortgage reduce my estate for Inheritance Tax purposes?

Yes. The outstanding Lifetime Mortgage balance, which includes the principal loan and all rolled-up interest, constitutes a liability against your estate. When IHT is calculated, this liability is deducted from the value of your assets, thus potentially reducing the taxable size of your estate.

What is the most significant tax-related risk of taking out equity release?

The primary financial risk related to tax is not the tax on the equity release itself, but the impact the resulting capital has on eligibility for means-tested benefits, such as Pension Credit. Losing entitlement to these benefits can often outweigh the financial gain of the lump sum received.

If I gift the equity release money to family, how does the 7-year rule affect my IHT planning?

If you gift the money, that gift is a Potentially Exempt Transfer (PET). It only becomes fully exempt from Inheritance Tax if you survive for seven years after making the gift. If you die within this period, the gift may still be counted back into your estate for IHT calculations, potentially negating the IHT benefit.

Can I deduct the cost of professional advice from my tax bill?

Fees paid to regulated financial advisers for personal advice, including equity release, are generally not tax-deductible in the UK, as they are considered personal financial costs rather than business expenses.

Summary of Tax and Benefit Considerations

The decision to pursue equity release should always involve a rigorous assessment of your current and future tax liabilities and benefit entitlements. While the tax-free nature of the funds is a major benefit, the subsequent consequences related to capital thresholds and estate planning require expert navigation.

Here is a concise summary of the key tax implications:

• Lump Sum Received: Tax-free (exempt from Income Tax and usually CGT).
• Interest Accrued: Not tax-deductible against personal income.
• Means-Tested Benefits: High risk of reduction or loss if the capital exceeds £16,000 (or lower limits).
• Inheritance Tax (IHT): Generally beneficial, as the rising debt (LTM) or reduced property ownership (HRP) lowers the net value of the estate.
• Gifts: Subject to the 7-year rule if funds are passed to beneficiaries.

It is vital to remember that equity release is a long-term financial commitment. While reducing IHT can be a goal, the immediate risk of losing essential state benefits must be fully understood and mitigated through professional advice.

Your property may be at risk if repayments are not made (in the rare instance that a provider requires interim payments, or in the case of a traditional mortgage that is being repaid via the equity release funds). Even with the standard “No Negative Equity Guarantee” offered by Equity Release Council members, the total cost of the loan can be substantial over time, significantly reducing the remaining value of the inheritance left for beneficiaries.

Promise Money strongly encourages all clients to engage an independent, specialist financial adviser to ensure that any equity release plan aligns perfectly with their tax situation and retirement goals.