Lifetime Mortgage to Mitigate Inheritance Tax Liability

Gifting money to family members to reduce your inheritance tax (IHT) liability is a well-known tax-planning strategy: after 7 years, gifted funds are deemed outside of your estate and no longer subject to IHT.

But if most of your wealth is tied up in your property, how do you pass it on without downsizing or having to sacrifice your cash reserves and savings instead?

Gifting your entire property is rarely a realistic option: HMRC states that a main residence cannot be gifted outside of your estate unless you then pay a fair market rent to live in the property. For a large family home, this is typically a significant monthly cost.

But lifetime mortgages, a form of equity release, can present a flexible and cost-effective solution when applied in conjunction with a holistic IHT mitigation plan. Here's how it can work in practice.

The Scenario

We were approached by a client facing the challenges described above.

• He was 75 years of age

• Living alone in his £1.5m property

• With £50,000 in savings, and pension income of £5,000 per month

He had one son, who was financially independent, but did not own his own home.

At the time, the client was looking at the following IHT scenario if they were to pass away:

• Estate value = £1,500,000 (property) + £50,000 (savings) = £1,550,000

• IHT allowance (including the main residence nil-rate band) = £500,000

• IHT rate = 40%

Calculation:

Taxable portion of estate = Estate value - IHT allowance

= £1,550,000 - £500,000

= £1,050,000

IHT due = Taxable portion × IHT rate

= £1,050,000 × 0.4

= £420,000

So, he needed to explore alternative and cost-effective solutions to gift his wealth, without the need for downsizing.

The Solution

At Clifton Private Finance, we take a holistic approach to our advice. We factor in your broader financial circumstances and priorities and can work closely with your wealth managers, financial advisers, and accountants where necessary.

Releasing giftable funds via a lifetime mortgage:

Working with a lifetime mortgage specialist, a £400,000 lifetime mortgage was released from the £1.5m property, which would be gifted to the client's son as cash.

After 7 years, this £400,000 would be deemed outside of the client's estate, likely saving £160,000 in inheritance tax.

The interest rate on the lifetime mortgages was 6.57% AER. However, these costs can often be greatly offset by both the savings in inheritance tax, and by the convenience and practicality of not having to sell your family home.

You can stay invested in the property market to a greater extent, and you don't have to change your lifestyle and living situation by downsizing.

Let's look at a 15-year projection to see how this scenario could play out:

• Interest on the £400,000 loan will be charged at 6.57% MER, which over 15 years would amount to £668,000, and taking the gross debt to £1,068,000.

• Incurring this £668,000 interest will also offset a further £267,200 in inheritance tax from the estate (the taxable estate value is reduced by the debt).

This means that the 'effective interest rate' of the loan would be c3.94%, because while £668,000 has accrued in interest, £427,200 has been saved in IHT, leaving a difference of just £240,800.

Now, let's also look at the potential results of being able to remain invested in the property market at maximum levels over that time:

• David's property could feasibly increase in value by £837,000 to £2,337,000 over 15 years (assuming 3% p/a property value growth), outrunning the £668,000 interest charged on the lifetime mortgage.

• David's son will also own a property worth £400,000, with no mortgage repayments to make.

• And this property could also increase in value by £223,000 to £623,000 after 15 years (again assuming 3% p/a property value growth).

While certain assumptions are made regarding the property market in this scenario, it paints a picture of why long-term, strategic debt planning is an essential part of any IHT scenario.

Related: Can I Get a Bridging Loan to Pay Inheritance Tax?