Financial expert Peter Sharkey explains why it's so important that homeowners pay attention to the implications of Inheritance Tax.

Dame Vera Lynn’s greatest hits album, We'll Meet Again, climbed to number two in September 2009 – the last time the Inheritance Tax threshold was raised.

As inflation continues to extend its influence across virtually every area of normal life, so people have become increasingly inclined to embark on an exhaustive search for savings.

Great swathes of people have cancelled subscriptions to gyms and magazines, while last month, streaming platform Netflix announced the loss of 1.2 million subscribers since the beginning of 2022

Cafes, pubs and tourist attractions, many seriously damaged by the pandemic’s impact, report significant falls in visitor numbers and, as fuel prices remain uncomfortably high, motorists are driving more cautiously in an attempt to preserve fuel.

Anecdotal evidence suggests that inflation’s attack on the nation’s purses and wallets has succeeded in making folks considerably more cost-conscious than they were. If there’s a silver lining with which people can console themselves, however, it’s the knowledge that inflation is traditionally good news for property values.

Economists would agree that this is broadly accurate, although there is a ‘but’ which involves a future tax to which a growing number of homeowners are theoretically liable, but to which few pay much attention, often to their cost.

Once upon a time, Inheritance Tax (IHT) was considered a liability reserved solely for the wealthy. Yet as property values have soared over the past 30-plus years, so tens of thousands of homeowners have been drawn into the IHT net.

Today, the chances of getting caught and incurring a sizeable Inheritance Tax liability has increased markedly because the threshold (the point at which IHT becomes payable) has remained unchanged, at £325,000, since 2009.

Things were once very different: between 1986 and 2008, the threshold rose every year. The effect of keeping it frozen for 13 years has been to make large numbers of homeowners (or their children) liable for the tax.

Inheritance Tax is a tax on the estate (the property, money and possessions) of someone who’s died.
There’s normally no inheritance tax to pay if either: the value of your estate is below the £325,000 threshold, or you leave everything above the £325,000 threshold to your spouse, civil partner, a charity or a community amateur sports club.

The standard Inheritance Tax rate is 40pc, which is charged on the part of your estate that’s above the threshold.

For example, if your estate is worth £500,000 and your tax-free threshold is £325,000, the Inheritance Tax charged will be 40pc of £175,000 (£500,000 minus £325,000). In this instance, the tax due will be an eye-watering £70,000.

However, releasing a proportion of the equity built up in your home will reduce your property’s value and, as a consequence, lower – or possibly eliminate – your IHT liability altogether when you die. It’s also important to note that any equity released from your home is tax-free.

Not surprisingly, equity release has become a popular method for property owners aged 55+ to release tax-free funds from their property and effectively reduce future Inheritance Tax liability. Indeed, figures recently published by the Equity Release Council revealed that almost 12,500 equity release plans were agreed in just three months between April and June 2022 as homeowners withdrew £1.6 billion from their property.

Although equity release will reduce Inheritance Tax liability, the process of effectively drawing money from your property can also bring great personal joy as the funds can be passed on (or ‘gifted’) to your beneficiaries, including children and grandchildren. Provided the donor lives for at least seven years after the gift(s) have been made, they fall outside of the IHT calculation. The donor also has the satisfaction of seeing their gifts put to good use by their beneficiaries.

Equity release can also be used by retirees to reduce a future IHT liability. Replacing funds drawn from a private pension with tax-free equity release funds will, in many instances, preserve the pension’s longer-term value because funds within the pension are not liable to IHT when passed on to a spouse/civil partner.

As millions undertake an ongoing search for savings to minimise inflation’s recurrent blow to the pocket, considering long term options such as equity release which help avoid a hefty tax bill makes enormous sense.

For more financial advice, check out Peter Sharkey’s regular blog, The Week In Numbers.

Equity release example

Mrs D is 78 years old. Widowed four years ago, her late husband left all of his wealth to her. She owns a house valued at £750,000, while her other assets and investments are worth around £150,000, a total estate value of £900,000. She has three daughters who will be the sole beneficiaries of her estate.

On paper, Mrs D’s daughters could be faced with a significant IHT bill of £230,000 (40pc of £575,000*). However, releasing £300,000 in equity from her home has enabled Mrs D to make gifts of £100,000 to each of her daughters and retain equity of £450,000 should she decide at some point to downsize or move into care.

Between them, Mrs D’s daughters have agreed to pay the interest on the equity release mortgage each month to ensure it remains fixed at £300,000. Provided Mrs D lives for at least seven years, the gifts to her daughters will fall outside of the IHT calculation, while the remaining debt will reduce the value of her estate.

*£900,000 (estate value) minus £325,000 (IHT threshold) equals £575,000.