Article | April 2007 | by Duncan Young
Is Equity Release the solution for inheritance tax problems?
Inheritance tax (IHT) has the ability to raise all sorts of severe emotions amongst people. It is seen as an unjust tax – a tax on savings and hard work, a double tax - because income tax or capital gains tax has already been paid and a tax that penalises those who do not rely on the state in their old age. And with current house price levels the incidence of this tax is rising fast notwithstanding the government’s raising of threshold eventually to £350,000 from the current £285,000.
With this hatred, not too strong a word I think, of IHT an industry of avoidance has grown up which the government has battled with over the years. It has been one new idea by the tax planners and then a response from the government. This game of chess reached its nadir with the debacle of the retrospective nature of the government’s pre-owned asset tax changes of a couple of years ago. These still reverberate as many are still suffering considerable loss and inconvenience as a result.
But to analyse the hoops that the 20,000 who entered into the trust arrangements were prepared to go through re-emphasises the depth of feeling. People were prepared to give up large chunks of their assets into a trust, albeit with a degree of residual control. Often a dual trust had to be arranged at no small initial and subsequent cost.
So to repeat the question - Is equity release the answer or at least an acceptable answer to meet inheritance tax liability? My position is that for most people it is not and there are two main reasons for this.
The first is that for most couples it is relatively straight forward to increase their tax threshold for IHT from the current £285,000 to £570,000 – and this shortly will be £700,000. At this latter figure most couples will not have much of a liability. The volume of property within the IHT liability threshold tails off very rapidly over £500,000.The way for couples to double the allowance is easy. They put their property in a type of tenure called tenants in common rather than the more conventional joint tenancy. With a tenants in common tenure each partner owns outright 50% (or some other agreed percentage) of the home which can be willed separately to children or other beneficiaries. On death a share of the property passes to the beneficiaries but they will not have power to force a sale of the property. So the surviving partner can carry on living in the property unaffected. The switch from joint tenancy to tenants in common is simple, only one piece of paper to sign, and it is cheap too. Immediately tax on £285,000 or £114,000 is saved with no waiting for seven years or any, or all, of the other controls coming into play.
But there are people who are not married or couples with taxable assets in excess of £700,000. Surely equity release is an option for them? Maybe or maybe not. Let’s take an example. A single man has taxable assets of £1,000,000 and so his estate on death will have a liability of 40% over the threshold – let’s assume £350,000. So the tax liability is £260,000 – a lot of money. If he were to borrow £500,000 under a lifetime mortgage and give the money away, so long as he lived for 7 years then his tax liability could well be zero as his mortgage will have accrued to over £800,000. So assuming no asset inflation he has saved £260,000 in tax by increasing his debt by £300,000. By using different assumptions on asset growth it is easy to produce a position that the return from the equity release is not negative. But the problem here is that equity release is an inflexible contract often with high early redemption charges, if the contract has to be unwound and assumptions on asset inflation have to be made to justify it. Is this a sensible way forward for the majority who are only on the cusp of the IHT threshold?
For some they will be happy that assets increase in the time to death and that they will live for seven or more years. For them equity release is worth considering. Depending on the person’s financial acumen it might be possible for an adviser to recommend a portfolio of AIM shares be acquired with the proceeds of the equity release fund raising. Here, so long as the shares are held for two years, the tax liability is reduced significantly.
If, however, they have property of significant value and are content with a fairly inflexible arrangement their adviser ought to consider Property Wealth Manager. It is in effect a do it yourself equity release scheme using life company policies backed by reversion interests in a person’s home. It is clever and I am told it has all the necessary consents and approvals.
I have stated my belief that equity release is far from being a panacea for IHT – a view shared by many leading brokers and regulators, so I am far from being in a minority on this. Yet many see and promote equity release and IHT in the same breathe, and I would argue that this says more about the state of the equity release market than anything else.
The market has stagnated over the last couple of years and with drawdown products the average size of advances has fallen sharply. So many brokers and product providers alike are suffering because their business is not growing as fast or with as low administrative costs as they were at first anticipating. In these circumstances the linking of IHT and equity release may start to make some sense.