Equity release and inheritance tax: what you need to know

If you're weighing up equity release and inheritance tax together, you're not alone. Inheritance tax (IHT) thresholds have been frozen since 2021 and are set to stay frozen until at least 2030, while house prices keep climbing, so more estates are being pulled into the tax net every year. If you're new to the topic, our guide to what is equity release explains the basics of lifetime mortgages and home reversion plans.

Equity release can genuinely reduce an IHT bill in some circumstances, but it comes with real costs of its own. This guide walks through how the mechanism works, when it helps, and when it's not worth it.

Inheritance tax is charged at 40% on the value of your estate above certain thresholds when you die. The main allowance is the nil-rate band (NRB) of £325,000. On top of that, most people passing a home to children or grandchildren get an additional residence nil-rate band (RNRB) of £175,000.

Married couples and civil partners can transfer any unused allowance to their surviving spouse, meaning a couple can typically pass on up to £650,000 tax-free, or up to £1,000,000 if the RNRB applies in full. Anything above these thresholds is taxed at 40%.

These figures are set by HM Revenue & Customs and have been frozen until at least 2030, meaning more households are likely to face an IHT bill as property values rise. Inheritance tax rules are the same whether you live in England, Wales, Scotland, or Northern Ireland, although some aspects of the conveyancing process differ outside England and Wales.

The residence nil-rate band explained

The RNRB only applies if you leave your home, or a share of it, to direct descendants, meaning children, grandchildren, step-children, or adopted children. It doesn't apply if you leave your home to a sibling, niece, nephew, or friend.

The allowance tapers away for larger estates: it reduces by £1 for every £2 your estate is worth over £2 million, and disappears entirely for estates above roughly £2.35 million.

In practice, this means many couples are not actually liable for inheritance tax once spousal transfers and the RNRB are taken into account. It's worth checking your own position with an advisor before assuming you need equity release for IHT planning at all.

Yes, equity release can reduce an inheritance tax bill, but the saving is often smaller than it first appears once you account for the cost of borrowing. Here's the mechanism behind it.

With a lifetime mortgage, you borrow against your home and the loan, including any interest that rolls up, is deducted from your estate's value when it's calculated for IHT purposes. The bigger the outstanding loan at death, the smaller the taxable estate.

With a home reversion plan, you sell a percentage of your property to the provider outright. That percentage no longer belongs to you, so it's removed from your estate immediately rather than building up as debt over time.

Either way, the reduction in your estate's value can bring you under the IHT threshold, or reduce the amount taxed at 40%. But equity release isn't free money: interest on a lifetime mortgage compounds over time, and the overall cost can eat into, or even exceed, the tax saving. The worked example below shows how this can play out.

This example is illustrative only and uses rounded figures. Your own numbers will depend on your property value, how much you release, how long the loan runs, and the interest rate your lender applies. A lifetime mortgage is secured against your home, and your home may be repossessed if you do not keep up repayments on it or any other debt secured against it. Speak to an advisor for a personalised illustration based on your circumstances.

The single biggest risk in using equity release for inheritance tax planning is compound interest. Unlike a standard mortgage, most lifetime mortgages don't require monthly repayments, so interest is added to the loan and then interest is charged on that interest too. Over a long enough period, the loan balance can grow substantially.

The table below illustrates how an outstanding balance might grow over time. It uses rounded, illustrative figures only, because the actual growth depends on the interest rate your lender applies, which varies by product and provider.

This is why timing matters so much. If you live for a shorter period after releasing equity, the IHT saving is more likely to outweigh the interest cost. If you live considerably longer, the interest can catch up with, or overtake, the tax you've saved.

Equity release for IHT planning tends to make the most sense for larger estates, where a substantial amount would otherwise be taxed at 40%, and less sense for estates that are only modestly over the threshold. Current equity release rates vary by lender and product, so it's worth comparing your options with an advisor rather than relying on rough estimates.

These figures are illustrative only. Interest rates vary by lender, product, and individual circumstances, so ask your advisor for a personalised illustration using current rates before making a decision.

Some people release equity specifically to gift money to family while they're still around to see it help, rather than leaving it as an inheritance. This is sometimes called a living inheritance. Gifting reduces your estate's value, provided you survive long enough after making the gift.

Everyone has an annual gifting exemption of £3,000, which can be carried forward one year if unused. You can also give up to £250 to any number of individuals each year, make wedding gifts within set limits, and make regular gifts out of surplus income without them counting towards your estate at all.

The 7-year rule covers larger gifts above these exemptions. If you survive for seven years after making a gift, it falls outside your estate entirely and no inheritance tax is due on it. If you die within seven years, the gift may be taxed on a sliding scale known as taper relief.

The 'living inheritance' strategy

Releasing equity to gift money now, rather than leaving it in your estate, lets you see the benefit while you're alive, such as helping a child with a deposit. The trade-off is risk: if you need long-term care within seven years of making the gift, means-tested benefits assessments can still count that gifted money as part of your assets, even though it's no longer legally yours.

Gifted funds can also affect a recipient's own entitlement to means-tested benefits in some cases, so it's worth thinking through the wider family picture before gifting a large sum.

Inheritance protection is an optional feature on many lifetime mortgages that lets you guarantee a percentage of your property's future value for your beneficiaries, regardless of how much interest rolls up on the loan.

It works by capping the maximum loan-to-value the lender will ever take from the property. Because a portion of the equity is ring-fenced from the outset, that value can't be eroded by compounding interest later on.

The trade-off is that inheritance protection reduces how much you can release in the first place, and lenders may apply different terms to plans with this feature. It tends to suit people who have a lower IHT liability but still want certainty over what their family will receive.

Equity release isn't always worth it purely for inheritance tax planning. In some cases the numbers simply don't add up, or there's a simpler option available.

It's less likely to be worthwhile if any of the following apply to you:

• Your estate is already below the effective threshold once spousal transfers and the RNRB are accounted for, so there's no IHT bill to reduce in the first place.
• You're in poor health, meaning the loan may not run long enough for the IHT saving to outweigh the interest that builds up before you die.
• You'd rather keep full ownership of your home and use other planning tools instead.

It's worth remembering that equity release will reduce the value of your estate and may affect your entitlement to means-tested benefits, so it needs weighing up against your wider financial position, not just your IHT bill.

Some homeowners also consider a more conventional approach, such as choosing to remortgage to release equity, rather than taking out a lifetime mortgage. This can work out cheaper if you can afford monthly repayments, though it will be assessed on affordability in the usual way rather than against the value of your home alone.

This page is for information only and doesn't constitute tax or legal advice. Speak to a qualified tax advisor or solicitor alongside your equity release advisor before making decisions about inheritance tax planning.

If you're inheriting a property that has a lifetime mortgage or home reversion plan attached, here's what typically happens next. When the last surviving borrower dies or moves into long-term care, the loan becomes repayable, and the estate usually has around 12 months to settle it, though this can vary by lender.

Equity release is a regulated product, and by law it must be taken out with regulated financial advice, so you can't simply choose a plan yourself without speaking to an advisor first.

Because we compare a wide range of lenders, an advisor can look at plans from across the market rather than steering you towards a single provider's products, and can help you weigh up whether equity release genuinely helps your inheritance tax position, or whether one of the best equity release companies for your circumstances might offer a more suitable structure, such as inheritance protection or a drawdown facility.

A lifetime mortgage is secured against your home, and your home may be repossessed if you do not keep up repayments on it or any other debt secured against it.

If you're feeling unsure or overwhelmed by any of this, MoneyHelper (moneyhelper.org.uk, 0800 138 7777) offers free, independent guidance and is a good place to start alongside regulated advice.