Inheritance Tax and the family home

The value of the family home on its own can often result in an Inheritance Tax (IHT) bill.

After April 2027, the value of personal pensions will be included in the estate, meaning hundreds of thousands if not millions more people will have to start paying IHT.

Gifting money to children or into trust and surviving 7 years is a decent option, but most people need the money themselves to enjoy their autumn years and so for most families this isn't really possible.

So we end back at square one where the value of the family home is going to cause an IHT bill. So what can we do?

If you transfer the ownership of your home to your children but continue to live in it, this is classed as a "gift with a reservation of benefit" and on your death, the house will still be in your estate for IHT purposes. So this will NOT work. You can get round this if you pay your children full market rent for the rest of your life. This could be a substantial amount of money (normally 3-5% of the value of the property) and if you could no longer afford the payments, or if you dropped the rent to below-market rates, you would fall foul of the rules. So in practice, few people ever go down this route.

You could downsize, transfer some or all of the released equity either directly to your children or into trust and hope to live for seven years. After seven years, the money you gifted is outside your estate for IHT purposes. The Residence Nil Band (an extra IHT exemption of £175,000 per person) is still available via the "Downsizing Addition" so you don't lose the relief by moving to a less valuable home.

But what if you like your home and don't want to sell it?

Well, you could release equity from the house, pass it to your children or put it into trust and hope to live for seven years. This would involve taking out an equity release mortgage. These typically cost about 6% per annum in interest and as you do not pay back the interest, the debt accumulates with rolled up interest. So if you are lucky enough to live a long life, the debt could be quite substantial. However, don't forget that the capital you passed to your children would have been put to good effect and there would be no IHT to pay after seven years. Furthermore, if you had placed the capital in trust and invested it into global equities, you might hope to achieve 10% per annum long-term returns, all free of IHT. Don't forget that the roll-up of interest will be further reducing the value of the estate and therefore reducing the IHT bill.

However, what would be better, if you can afford it, is to opt for a very long interest-only mortgage whilst you are still working, or a Retirement Interest-only (RIO) mortgage if you are not. By making the monthly interest-only payments, you stop the debt from accumulating, you start the seven-year clock ticking by gifting the released equity to your children or into trust and after seven years, there is no IHT to pay. Furthermore, if you place the equity into trust, all growth in the trust is exempt from IHT too. These types of products offer rates normally sub 5%, making them cheaper than full equity release rates.

And if in your twilight years, the monthly payment becomes too much, you could then re-mortgage to a full equity release product with no monthly payments required. The negative effect of rolled-up, compound interest would not be so severe due to your great age and consequently reduced life expectancy.

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