Equity Release and the Next Generation

Financial Planner Gary McKenzie explains how Equity Release can play a role in legacy planning.

I recently overheard my daughter, Libby, telling her friend that she did not have to worry about getting a job, as when she gets older her dad will give her money to buy a house. I was quick to remind Libby that her dad is a Financial Planner and therefore known for his financial prudence (comparisons have been drawn to Alistair Sim’s depiction of Scrooge on more than one occasion).

Libby’s optimism for her inheritance aside, the topic of what (and when) we will leave to our loved ones is an important one. As we are all living longer, (the number of centenarians worldwide is expected to reach 573,000 this year [1]), traditional beneficiaries of estates are receiving their inheritance when they themselves are in retirement, well past the point of needing capital for a house deposit or a helping hand as working life begins. It is no surprise, then, that passing wealth to the next generation while we are still alive to see them enjoy it is becoming ever more popular.

On the other hand, as we live longer, our savings and investments become more important to sustain our lifestyles, leaving less to gift to our children. Most beneficiaries can now instead expect their inheritance to come from the sale of the family home, with a series of staggering statistics highlighting that over 50’s in the UK now have around £2.8 trillion tied up in home equity [2]. So how then do we tap into this wealth during our lifetime without handing over the house keys to the kids?

Equity Release has been around in one form or another for many years, but the introduction in recent years of products like the Lifetime Mortgage has increased its popularity. In essence, this is a loan secured against the value of your property, but, unlike a traditional bank loan or mortgage, there is no expectation to repay the loan during your lifetime. Instead, you can choose to either make the interest payments on a regular basis or roll these up into the outstanding balance. In most cases, the outstanding loan is then repaid when you die or move into long-term care permanently, at which point the property is sold. The terms of the loan depend on various factors including your age, but most borrowers can expect to release a maximum of 55-60% of their property value.

To highlight how Equity Release can work, let us look at an example:

Ann and Jim are retired and living off of their guaranteed pension income and rental income. They have an estate worth £1.1m of which the majority is tied up in the family home (valued at £500,000) and their two buy-to-let properties. Their son, George, is looking to buy his first house and needs a deposit of £60,000. Unfortunately, Ann and Jim have little in the way of liquid assets (e.g.cash) with which to help George. They have also been considering replacing their cars and motorhome but are concerned about wiping out their emergency savings fund.

Ann and Jim’s age, guaranteed income and the value of their main residence make them a good candidate for Equity Release. They release £100,000, from which they gift George his deposit and replace their cars and motorhome. They agree with their Financial Adviser that the interest payments on the loan are affordable and make these monthly. The original £100,000 will eventually be repaid via the sale of their property, but only once both Ann and Jim have passed away or have both entered long-term care. They also have the option of borrowing additional money in the future, should they need it.

Whilst the obvious benefit here was Ann and Jim’s ability to release money from their estate to help George, they have also gone some way to reducing the net value of their estate. A married couple can currently bequeath up to £1m in assets upon death without their estate incurring an Inheritance Tax charge (40% of the excess) and so by releasing and gifting/spending £100,000, Ann and Jim have potentially saved their beneficiaries up to £40,000 in Inheritance Tax. The full details of how mitigating this tax might work, however, are best left for another article…

Equity Release has previously received a lot of bad press; however, the last 25 years has seen regulation within the industry improve dramatically. The Equity Release Council, founded in 1991, has developed new codes of conduct to safeguard consumers which have reshaped Equity Release into a useful strategy for both additional income in retirement and to facilitate the passing of wealth early to help children or grandchildren. Nevertheless, this a complex area of financial planning and is not the right decision for everyone; you should always seek professional advice before making a decision.

To conclude the story regarding Libby, as we went out of the door on the way to shops, she quietly took my hand. In that moment, Libby’s claim to her inheritance was secure. I remember thinking that children really know how to play their parents, and if I was in any doubt…

…“Total lending by the Bank of Mum and Dad means it is effectively the 11th largest lender in the UK and helps to fund one in five of all home purchases.” (Money Marketing [3]).

Gary McKenzie DipPFS
Financial Planner