How to Reduce Inheritance Tax (IHT) by Withdrawing Money from Your House

02/10/2021 - 9 minutes read

One of the most frequently asked questions by our clients these days is how to reduce Inheritance Tax (IHT)?

In this article, we will aim to shed some light on how to reduce Inheritance tax by withdrawing money from your house.

As houses prices continue to skyrocket, older property owners find themselves sitting on rather large sums of equity built up in their homes thereby increasing the value of their estate above the IHT threshold and you may want to consider the benefits of equity release when considering your options on how to reduce inheritance tax.

What is the nil rate tax-free allowance for IHT?

The nil rate tax-free allowance for IHT has been frozen since 2010 and it will not go up until at least 2026.

Everyone gets a £325,000 nil-rate IHT allowance, plus another £175,000 if you pass a main residence worth up to £2 million on to a direct descendant. Everything you leave to a spouse or a civil partner is IHT-free and you can inherit their allowance too, so a couple have a  potential allowance of £1 million.

The inheritance tax rules state that you can make financial gifts tax-free so long as you live for seven years after making the gifts. Giving away money can also reduce the value of your estate, making it less likely that your loved ones will have to pay inheritance tax.

Any money owed on equity release is taken into consideration when assessing potential care costs, so it would reduce the overall bill that a family may face.

Inheritance Tax rates

The standard Inheritance Tax rate is 40%. It’s only charged on the part of your estate that’s above the threshold.

Example: Your estate is worth £500,000 and your tax-free threshold is £325,000. The Inheritance Tax charged will be 40% of £175,000 (£500,000 minus £325,000).

The estate can pay Inheritance Tax at a reduced rate of 36% on some assets if you leave 10% or more of the ‘net value’ to charity in your will.

How to reduce Inheritance tax

How to Reduce Inheritance Tax (IHT) by Withdrawing Money from Your House

Can I use equity release to reduce Inheritance tax?

Equity release, where you free up cash from the value of your home by taking out a mortgage that lasts until you die or move into care, was once only considered suitable for those with debts or little pension income but many older people who have benefited from the value of their homes increase dramatically in their lifetime are now using equity release to reduce inheritance tax as well to help their children & grandchildren by gifting them cash which they can use as a deposit to get on the housing ladder, help with university fees, pay for wedding costs etc.

Whilst equity release can be taken out to from the age of 55, this may be too soon to start tax planning. Those who want to give away some of their estate to avoid care home fees should also be careful because councils can deny funding to anyone they believe has deliberately given away their money.

How to Reduce Inheritance Tax – Rules on giving gifts

Inheritance Tax may have to be paid after your death on some gifts you’ve given.

Gifts given less than 7 years before you die may be taxed depending on:

  • – who you give the gift to and their relationship to you
  • – the value of the gift
  • – when the gift was given

What counts as a gift

Gifts include:

  • – money
  • – household and personal goods, for example, furniture, jewellery or antiques
  • – a house, land or buildings
  • – stocks and shares listed on the London Stock Exchange
  • – unlisted shares you held for less than 2 years before your death

A gift can also include any money you lose when you sell something for less than it’s worth. For example, if you sell your house to your child for less than its market value, the difference in value counts as a gift.

Anything you leave in your will does not count as a gift but is part of your estate. Your estate is all your money, property and possessions left when you die. The value of your estate will be used to work out if Inheritance Tax needs to be paid.

Reliefs and exemptions

Some gifts you give while you’re alive may be taxed after your death. Depending on when you gave the gift, ‘taper relief’ might mean the Inheritance Tax charged on the gift is less than 40%.

The 7-year rule

No tax is due on any gifts you give if you live for 7 years after giving them – unless the gift is part of a trust. This is known as the 7-year rule.

If you die within 7 years of giving a gift and there’s Inheritance Tax to pay, the amount of tax due depends on when you gave it.

Gifts given in the 3 years before your death are taxed at 40%.

Gifts given 3 to 7 years before your death are taxed on a sliding scale known as ‘taper relief’.

Taper relief

Years between gift and deathRate of tax on the gift
3 to 4 years32%
4 to 5 years24%
5 to 6 years16%
6 to 7 years8%
7 or more0%

What do I need to consider before releasing equity from my home?

Equity release had a controversial reputation in the last 20 – 30 years especially when borrowers took expensive loans that used up the entire value of the family home and many people did not consult their loved ones who only discovered the vast debt on the house when the borrower had passed away so please ensure you seek specialist advice prior to committing yourselves to an equity release product!

You should also consider whether downsizing may be a better option for you whereby you can use some of the funds generated by the sale of your property to make a gift to your loved ones.

Can pensions help reduce Inheritance tax?

Another popular suggestion from us on how to reduce inheritance tax is by leaving someone your pension as it can very tax-efficient. If you die before you are 75, the person who inherits your pension can make withdrawals without paying any tax. If you die after the age of 75, the beneficiary will pay tax on withdrawals at their marginal income tax rate.

If you can afford to leave your pension untouched while using other assets to fund your retirement, you could pass your pension on tax-efficiently whilst also reducing the size of your taxable estate for IHT purposes.

How can MCL Accountants help?

Contact MCL Accountants on 01702 593 029 if you have any queries on how to reduce Inheritance Tax or if you need any assistance with the preparation and submission of your business accounts or self-assessment tax returns to HMRC.

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