We were recently approached by a client who owned a mortgage-free property worth approximately £800,000.
The client had been offered the opportunity to release around £350,000 of equity from the property through a lifetime mortgage. His proposal was straightforward:
- Release £350,000 from the property.
- Gift the money to his children.
- Reduce the value of his estate for inheritance tax purposes.
- Reduce the amount of wealth potentially available to fund future care costs.
At first glance, this may appear to be an attractive planning opportunity. However, as with many tax and estate planning matters, the position is more complex than it first appears.
How Does Equity Release Work?
Equity release allows homeowners, typically aged 55 or over, to borrow against the value of their home without making monthly repayments.
The most common form is a lifetime mortgage.
Interest is added to the loan each year and the balance is usually repaid when the homeowner dies or permanently moves into long-term care.
In our client’s case, he could potentially borrow £350,000 against his £800,000 property.
Potential Inheritance Tax Benefits
One of the main attractions of this strategy is inheritance tax planning.
If the client gifts the £350,000 to his children and survives for seven years after making the gift, the value of that gift will normally fall outside his estate for inheritance tax purposes.
In addition, the equity release debt remains attached to the property.
This means that the estate may ultimately consist of:
- The value of the property less the outstanding equity release debt.
- Other remaining assets.
As a result, the value exposed to inheritance tax may be significantly reduced.
For families facing a potential inheritance tax liability, this can appear very attractive.
The Potential Savings
Using simple figures:
- Property value: £800,000
- Equity release: £350,000
- Gift to children: £350,000
If the client survives seven years, the gifted funds may fall outside the estate.
The estate would also have a substantial debt secured against the property.
Depending on the overall circumstances, this could produce a significant inheritance tax saving.
The Care Fees Question
This is where many people become interested in the strategy.
The logic often presented is:
“If I have already given £350,000 to my children, there is less money available to be used for future care costs.”
Unfortunately, the position is not that simple.
Deliberate Deprivation of Assets
Local authorities have powers to examine transactions where assets have been given away.
If they conclude that an individual deliberately reduced their assets in order to qualify for local authority assistance with care costs, they may treat the person as still owning those assets.
This is known as “notional capital”.
In practice, the local authority may assess the individual as though the gifted funds are still available to them, even though the money has already been passed to family members.
There is no automatic seven-year rule for care fee assessments.
The key question is often:
Why was the gift made?
If the primary motivation was avoiding future care fees, there is a greater risk of challenge.
Could the Family Be Affected?
Potentially, yes.
While the local authority will often focus on the person requiring care, legislation can allow recovery action in certain circumstances where assets have been transferred.
This can create uncertainty for both the donor and the recipients.
A strategy that appears straightforward today can become significantly more complicated years later.
The Cost of Equity Release
One factor that is often overlooked is the cost of borrowing.
Many lifetime mortgages currently carry interest rates significantly higher than standard residential mortgages.
Because interest rolls up over time, the outstanding balance can grow rapidly.
For example:
- Initial borrowing: £350,000
- Interest rate: 6%
- No repayments made
After 10 years, the balance could exceed £625,000.
After 15 years, it could exceed £835,000.
The exact figures will vary, but the principle remains the same: compound interest can substantially reduce the value of an estate.
Other Considerations
Before proceeding, clients should also consider:
- Their future income requirements.
- Potential care needs.
- Whether they may need access to capital later in life.
- The impact on means-tested benefits.
- Alternative inheritance tax planning opportunities.
- Whether downsizing may achieve similar objectives.
Advantages of the Strategy
Potential advantages include:
- Immediate financial assistance to children and grandchildren.
- Potential inheritance tax savings.
- Ability to enjoy seeing family benefit from wealth during lifetime.
- Reduction in the taxable value of the estate if the donor survives seven years.
- Retention of ownership and occupation of the family home.
Risks and Disadvantages
Potential disadvantages include:
- Significant compound interest costs.
- Reduced flexibility in later life.
- Possible challenge under deprivation of assets rules.
- Reduced inheritance for beneficiaries if borrowing costs escalate.
- Complexity around future care funding assessments.
- Potential impact on entitlement to means-tested support.
Our View
Every family’s circumstances are different.
Equity release can be a valuable tool when used for the right reasons and as part of a wider estate planning strategy. However, it should never be viewed as a guaranteed method of protecting assets from future care fees.
The inheritance tax position, care fee rules, borrowing costs and long-term financial needs all need to be considered together.
Before implementing any strategy involving significant gifts and equity release, we would strongly recommend obtaining advice from both a suitably qualified financial adviser and a solicitor specialising in later-life planning.
A decision made today could have consequences for decades to come.