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What is Inheritance Tax

Inheritance tax is a tax payable on the estate and assets of someone who has died. It is also due on any financial gifts made in the previous 7 years before death. The threshold for Inheritance tax is currently £325,000, so no tax will be payable if your estate is valued at less than this. You can also leave everything above the £325,000 threshold to your spouse or civil partner without any inheritance tax being due.

If you own your own home your tax free threshold can increase to £500,000 if you leave your house to your children or your estate is worth less than £2million.

You can also add any unused threshold to your partner’s threshold when you die

The standard rate of Inheritance tax is 40% and this is only charged on your estate above the value of your threshold.

How does the 7 year rule work

If you die within 7 years of giving a gift then inheritance tax may be due, however the amount payable will depend on how much is given and when the gift was made.

If the gift was given in the 3 years before death then inheritance tax is due at 40%. However, if the gift was made between 3 years and 7 years before death the amount charged will reduced on a sliding scale. This is known as taper relief.

How do annual exemptions work

HMRC will allow you to give away up to £3000 worth of gifts each tax year without them being included in the value of your estate. Any unused annual exemption can be carried into the next tax year but for 1 year only. So long as the value of any gifts given fall below the exemption figure no inheritance tax will be due, even if the giver dies within 7 years of the gift.

How can Equity Release be used as part of Inheritance Tax planning

Equity release enables you to release funds from your home without having to sell it. The most popular from of equity release is through a Lifetime Mortgage. This type of mortgage allows you to retain ownership of your home, with the loan becoming repayable when you either pass away or go into residential care.

Whilst taking out equity release will reduce the value of your estate and therefore the likelihood of your having to pay Inheritance Tax, the loan will attract interest on a compound basis. This means that you will pay interest on the interest already accrued. Therefore any savings on inheritance tax may be offset by the cost of the Lifetime Mortgage so it’s important to take professional tax and estate planning advice before considering using equity release as part of your inheritance tax planning.

If you use equity release to  gift money to someone else, such as your children or grandchildren then this will not attract inheritance tax so long as you live for 7 years after the gift is made. However if you do die within the 7 year period the value of the gift will be added back to your estate for the purpose of calculating inheritance tax.

Related: Equity Release and Paying for Care Costs