'No inheritance tax' deals

Stephen Pritchard explains how a lifetime mortgage can help you avoid paying out to the Inland Revenue
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The Independent Online

With the average house in the UK costing over £160,000 - according to the Halifax house price index - a growing number of homeowners face the prospect of inheritance tax taking a chunk out of their estate.

With the average house in the UK costing over £160,000 - according to the Halifax house price index - a growing number of homeowners face the prospect of inheritance tax taking a chunk out of their estate.

All estates worth over £263,000 are subject to inheritance tax at 40 per cent, and property forms an increasing part of many estates paying the charge. However, the Inland Revenue is known to be clamping down on households that gift property to their families, but continue to live there. So-called "lifetime mortgages" offer an alternative way to shelter property from inheritance tax - but only if they are used carefully.

Lifetime mortgages are of two main types. Under one arrangement, homeowners borrow against the value of their properties, and the interest rolls up during the duration of the loan. The debt is then repaid out of their estate. Alternatively, under a scheme known as a home reversion plan, the home owner sells their property in return for a lump sum, but retains the right to live there for the remainder of their lives.

Mike Boles, a director at Savills Private Finance, says that wealthier clients are the most likely to consider a lifetime mortgage as a way to deal with inheritance tax, and do so as part of an holistic approach to tax planning. Simply raising money through a lifetime mortgage will not, in itself, reduce someone's inheritance tax liability.

The only sure way to avoid paying inheritance tax is to give money away. Even this is not without restrictions. Anyone who wants to give away more than £3,000 - with some exceptions, such as on marriage - needs to live for seven years in order for the gift to fall outside the scope of inheritance tax. This is known as a potentially exempt transfer (PET).

This means that homeowners need to plan any lifetime mortgage, and how they want to handle gifts, before they reach old age, if they want it to be effective from an inheritance tax point of view.

According to John Whiting, senior tax partner at the accountants PriceWaterhouse Coopers, nor can the giver attach conditions to the gift. Handing money over to children, but expecting to receive the interest, for example, would fall foul of Inland Revenue rules. "It has to be gifted, no strings," he says. If a householder has the financial flexibility - and the foresight - to plan ahead, however, a lifetime mortgage will cut the inheritance tax bill. A home reversion plan takes the property out of the estate altogether, while a mortgage with which the interest rolls up will have to be paid off from the estate.

This comes at a cost. A homeowner will only be able to raise a fraction of the value of their home under a lifetime mortgage. The exact amount depends on the scheme and the age of the homeowner, but 40 per cent is a typical value.

Although most finance companies offering lifetime mortgage schemes offer a guarantee that the deal will not put the borrower into negative equity, homeowners need to be aware of the true costs. Savills Private Finance carried out a survey last year that showed rolling up interest at 7 per cent doubles the debt in just 10 years.

Today, the typical interest rate for a lifetime mortgage is 6.75 per cent, significantly higher than either the best five-year fixed-rate mortgages on the market, which are about 5 per cent, or even 10-year loans, currently running at 5.4 per cent. According to Mr Boles, the higher interest rates reflect the risks lenders have to take, as they cannot predict how long a lifetime mortgage customer will stay in the property. But it is the effect of compound interest that borrowers all too often underestimate.

Home reversion plans, where the homeowner transfers the property to the lender in return for a lump sum but stays on as, in effect, a tenant, might seem a tidier solution. However, Mr Boles says that such schemes are not popular. There is something unappealing about handing over ownership of the family home.

Owners will also lose out on any future house-price gains. Under an interest roll-up scheme, they will at least benefit from any rise in the property's value. Any surplus can be passed on to the beneficiaries of the estate in the normal manner. Home reversion plans usually offer a larger lump sum. Unlike other lifetime mortgages, home reversion plans are not currently regulated.

Homeowners do have another way of releasing capital and, potentially, reducing liability for inheritance tax: trading down the property ladder. This might be disruptive but families know how much the property has fetched, and there is no need to pay interest.

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