What is Equity Release and Who Benefits

This year will see further record-breaking double-digit growth in the Equity Release market largely driven by two very different types of client. The first are the classic asset rich and cash poor, sometimes couples but also very often widows whose husband has died and income has considerably reduced. The second client situation is for wealthier clients looking to apply a strategy to reduce inheritance tax.

Asset rich cash poor

For many years government policies have actively encouraged home ownership even ahead of other financial responsibilities such as the need for the provision of an adequate retirement pension. The good news is that the value of these homes has increased considerably and the owners have lower outgoings because they are not paying rent and no longer have a mortgage. However, many are surviving on a state pension and perhaps some additional small private pensions. This is fine for day to day expenditure but finances can become stressed if there is a higher than normal financial requirement. This can become even more acute if one of the couple sadly dies and there is an immediate reduction in both private and state pension income. Two can live as cheaply as one but try covering family household bills on a single state pension and modest private pension.

So how does Equity Release fit into this scenario?

Where your house has a value and typically no mortgage or a small residual mortgage, Equity Release allows clients typically age 55+ to take a percentage of the house value as a tax free cash lump sum. This cash sum can be used for any legal purpose - a new car, dream holiday, gift to children or simply to supplement the household income. Amounts can be quite modest say £10,000 or even much larger sums in excess of £1million.

Interest rates on these products are now at record lows and so if a client chooses to make no payments at all and allow the interest to roll up each year it will take about 17 years for the original debt to double. If interest is covered then it can be comparatively reasonable cost and £100,000 could cost just £335 per month. The most competitive interest rates are under 4% and these are lifetime fixed. So cover the interest each year if it suits, but even if you prefer not to, then the effect of interest roll up on this basis is far more sustainable than historic rates at c.7%. Rates at this level could see the debt double about every 10 years.

Case study 1

Mrs D age 84 living in a house £500,000 with husband having died some years previously. Absolutely no desire to move home but had depleted savings supplementing her state pension and small private pension. We did research available state benefits but the client was already claiming all that she was entitled. Her needs were increasing and she needed help around the house and garden. We provided a £100,000 equity release mortgage on an interest roll up basis and the ability to draw a further lump sum of £50,000 if ever needed.

Alongside this a lifetime annuity was provided and the client invested the £100,000 to provide an additional income of £12,000 per annum for the rest of her life. This was tax effective as the annuity income was classed as part return of capital and only the interest element was taxable. She could choose to cover interest each year of £4,000 or as needs increased or she decided to sell her property she could trade down and would still enjoy this additional income of £12,000 for the rest of her life. She could die early and the annuity would die with her but people are living longer and this solution was considered acceptable and provided considerable peace of mind.

Inheritance tax – planning and strategy

Property values have increased considerably in recent years and many properties are now in excess of £1million, providing their owners with a potential and increasing inheritance tax issue. Again, for owners over 55, Equity Release can be part of the solution with owners raising and using the tax free cash lump sum for their own purposes, gifting to their children or using tax effective investment solutions.

The attraction of using this strategy now is the very low lifetime interest rates, which start at under 4%. To cover interest at this level is usually sustainable with £100,000 costing just £4,000 per annum in interest.

Case study 2

Couple in their 70’s living in a house valued at about £1,500,000 and with other investments and a good income provided by a Self Invested Personal Pension (SIPP). The SIPP is invested and is outside of the clients estate for inheritance purposes. The clients were drawing on their pension each year.

The clients decided to raise an equity release mortgage of £500,000 against their personal home. These funds were for property improvements, to gift to their children and to provide funds to cover school fees for their grand children. The funds provide a real benefit to the family today and with a low fixed rate of 4% for the rest of their lives. They have sufficient income to cover interest in order to manage the roll up of interest. Products are also flexible so if they decide to allow interest to roll up then this is also acceptable.

At the same time as funds are removed from the estate the potential inheritance tax liability is reduced. An asset value of £500,000 above the Inheritance Tax Threshold would be taxed at 40% so £200,000. Another good reason to start planning for this issue.

Is now the right time to do something?

Interest rates have been at historically low levels for some time. However, it is only more recently that lifetime fixed equity release rates reduced to current low levels. Product terms have also changed making these products more attractive. A rate of 4% in itself is perhaps not the most competitive but lifetime fixed is the appeal and this could work out to be cheap money when viewed across the economic cycle. We have enjoyed low rates for some time and these rates look likely to continue at least with the uncertainty and in the run up to Brexit. If lifetime fixed rates did go up to say 6% this seems just a modest increase. However, this small interest change represents a substantial 50% cost increase from existing rates of around 4%.

How will Brexit evolve and who will be forming the next government? Where will rates go next? Well we know that they are unlikely to go lower than current historic low levels.

In the summer of this year 40% of NHS hospital beds were tied up with elderly patients who hospitals were unable to discharge because there was not an acceptable “care plan” in place. This winter is seeing this crisis build and 2018 is unlikely to see any improvement as the population continues to age. A lot of elderly patients are living in expensive houses but with insufficient income to provide for the care at home that they want and need. Equity release can provide this solution and a lot of families support their parents using their property for this purpose.

The answer for some is to prepare now and make sure resources are in place rather than wait for the worse to happen. With lifetime fixed interest rates of 4% there is unlikely to be a better time and this opportunity is unlikely to be around for much longer.